NJCPA Addresses BAIT Concerns
New Jersey enacted the Pass-Through Business Alternative Income Tax Act (BAIT), effective for tax years beginning on or after Jan. 1, 2020. The BAIT allows a qualifying pass-through entity (PTE) to elect to pay tax on the sum of the owners’ shares of income sourced to New Jersey. Each owner may claim a tax credit for the amount of tax paid by the electing PTE on the owner’s share of distributive proceeds.
The BAIT reduces the federal taxable income of the electing PTE allowing eligible owners effectively to deduct the full amount of the BAIT, overcoming the $10,000 SALT deduction limitation on the BAIT tax paid.
The New Jersey Division of Taxation has issued important guidance concerning the BAIT in cases where a lower-tier PTE has a member that is an upper-tier PTE. Under that guidance, each electing PTE in a tiered structure is required to pay the BAIT. This will result in duplicate BAIT payments.
The BAIT payment made by the lower-tier PTE will not flow through to the owners of the upper-tier PTE. Further, the upper-tier PTE cannot apply the BAIT credit received from the lower-tier PTE against its BAIT liability reported on Form PTE-100. A BAIT credit may only be claimed as a credit on an upper-tier PTE’s Form-NJ-CBT-1065 or Form CBT-100S, whichever applies.
PTE-Lower is a tax partnership owned by two New Jersey resident members: Individual A and PTE-Upper, a tax partnership. Individual A and PTE-Upper are 50-percent members.
PTE-Upper’s only asset is its interest in PTE-Lower. PTE-Upper is owned by two partners, Individual B and Individual C. Individual B and Individual C are 50-percent partners.
PTE-Lower has income of $1,500,000 that is 100-percent sourced to New Jersey. The New Jersey-sourced distributive proceeds are allocated $750,000 to Individual A and $750,000 to PTE-Upper. PTE-Lower’s BAIT liability is $108,687.50. Each member’s share of the BAIT equals $54,343.75 ($108,687.50*50%)
PTE-Lower will also file Form NJ-1065. As an electing BAIT taxpayer, PTE-Lower will also file Form PTE-100 and pay its BAIT liability of $108,687.50. PTE-Lower will report on separate Forms PTE K-1 the BAIT credit to which Individual A and PTE-Upper are entitled.
Individual A will file Form NJ-1040, including in income her share of distributive proceeds and claiming a BAIT credit of $54,343.75 against her GIT liability.
PTE-Upper’s only income is its share of distributive proceeds from PTE-Lower of $750,000. The distributive proceeds are allocated $375,000 to Individual B and $375,000 to Individual C. PTE-Upper’s BAIT liability is $46,787.50. Each member’s share of the BAIT equals $23,393.75 ($46,787.50*50%)
PTE-Upper will file Form NJ-1065. As an electing BAIT taxpayer, PTE-Upper will also file Form PTE-100 and pay its BAIT liability of $46,787.50. PTE-Upper will not be allowed to offset its BAIT liability with its share of the BAIT ($54,343.75) paid by AB. Instead, PTE-Upper will be required to file Form NJ-CBT-1065 to claim a credit for its share of the BAIT paid by AB, $54,343.75. PTE-Upper will report on separate Forms PTE K-1 the BAIT credit to which individuals B and C are each entitled.
Individual B and Individual C each will file Form NJ-1040, including in income the member’s share of distributive proceeds and claiming a BAIT credit of $23,393.75 against their GIT liability.
As a recap:
- PTE-Lower will pay a BAIT of $108,687.50 on Form PTE-100
- PTE-Upper also will pay a BAIT of $46,787.50 on Form PTE-100
- PTE-Upper separately must claim a refundable credit of $54,343.75 on Form NJ-CBT-1065
- Individual A will claim a refundable GIT credit of $54,343.75 on Form NJ-1040
- Individual B will claim a refundable GIT credit of $23,393.75 on Form NJ-1040
- Individual C will claim a refundable GIT credit of $23,393.75 on Form NJ-1040
The example illustrates the difficulty presented by the Division’s guidance. PTE-Lower and PTE-Upper each are required to file a Form-PTE-100 and pay the full BAIT amount due on the respective sum of their distributive proceeds. PTE-Upper may not claim on its PTE-100 a credit for its share of the BAIT paid by PTE-Lower. Instead, PTE-Upper will have to file separately Form NJ-CBT-1065 to claim a refundable credit for the BAIT paid by PTE-Lower on its behalf.
CAUTION: Additional consideration must be given to tiered structures with an S corporation as an upper-tier member. It is not clear whether the Division will allow the upper-tier S corporation a refund on the CBT 100S of BAIT payments made by a lower-tier partnership. Instead, the Division may only allow the upper-tier S corporation to take a BAIT credit against corporation business tax (CBT), other than the CBT minimum tax. This will likely trap the BAIT credit in the upper-tier S corporation (because S corporations generally do not pay CBT, other than the minimum tax) and risk the eventual loss of the BAIT credit corporate carryforward, which expires after 20 years.
PTEs that file an election to pay the BAIT must file Form PTE-100 and pay the tax due. Form PTE-100 and its instructions require the use of federal Schedule K amounts when computing taxable distributive proceeds. Neither Form PTE-100 nor the instructions, as presently drafted, make provisions for New Jersey additions or subtractions; most notably, an addback to federal income for the BAIT tax paid and deducted when computing federal income. Other common adjustments not addressed include any federal-to-New Jersey depreciation adjustments and items like tax-exempt interest and the 50-percent/100-percent meals and entertainment deduction.
Form PTE-100 does not presently accommodate the crediting of a current-year BAIT overpayment to the following year’s BAIT. Without the ability to apply a current-year overpayment against the following year’s BAIT, PTEs will be required to make increased estimated tax payment for the following year while waiting for a refund of the current year’s overpayment.
Guidance from IRS and Other States
The IRS announced it will propose regulations clarifying that state and local income taxes imposed on and paid by a partnership or an S corporation on its income are allowed as a federal tax deduction by the partnership or S corporation in computing its non-separately stated taxable income or loss for the taxable year of payment.
There remains some uncertainty if the IRS will apply a “tax benefit” rule to refunds at the member level due to disparities in computing the BAIT. Consider the following example:
- S corporation A is located in New Jersey so property and payroll factors are high but its in-state sales are low.
- Owner B is a Florida individual.
- S corporation A properly determines that its BAIT liability is $100,000 and makes an estimate for $100,000 on Dec. 31, 2020.
- Owner B determines their 2020 New Jersey tax liability to be $40,000 since income is on B’s K-1 from S corporation A is ultimately allocated to New Jersey on the K-1 using a single-sales factor.
- Assume Owner B pays no estimates to New Jersey for 2020 and Owner B is issued a New Jersey refundable refund of $60,000 in 2021 for its distributive BAIT credit.
- It is unclear if the IRS will require taxpayers to include in income at the entity level for refunds that gave rise to a deduction in the previous year, diluting some of the potential BAIT election benefit.
In addition, members should be careful to consider the potential double taxation issues associated with electing the BAIT for owners of PTEs that are non-residents of New Jersey.
- New York: In their instructions for a resident credit, New York not provide a credit for entity-levels taxes, like the BAIT, on the individual return.
- Pennsylvania: The guidance appears to permit a credit for the BAIT if flowing through an S corporation, but not if from a partnership.
- Connecticut: The state provides a resident credit if it identifies a qualifying jurisdiction that imposes an entity-level tax that that is “substantially similar” to its pass-through entity tax. As such, it would appear the PTE taxes would be viewed as substantially similar, but Connecticut has not provided any formal guidance to date.
The New Jersey Legislature intended for the BAIT to provide an efficient, state-tax-neutral means of preserving an uncapped federal tax deduction for state income tax on business income. The NJCPA is working with Division of Taxation to clarify the Division’s BAIT guidance, to simplify the treatment of tiered structures and to eliminate unnecessary duplicate payments.