New Jersey BAIT Pass-Through Entity Taxation

The Tax Cuts and Jobs Act of 2017 made several favorable tax changes that provided meaningful benefits to businesses. Unfortunately, there were also changes that had an adverse impact on the same taxpayers. One important example is the $10,000 cap on the deduction for state and local taxes. Unfortunately, this modification created tax complications for owners of S-corporations, partnerships, and other pass-through entities. Essentially, it forced more of the tax burden on the individual tax returns of owners.

As a means of remedying the issue, many states elected to create a state and local tax (SALT) cap workaround. In 2020, New Jersey’s Business Alternative Income Tax (BAIT) was created to allow impacted businesses to pay taxes at the entity level and not the individual level. At the time, it was estimated to save between $200M – $400M annually. More recently, there have been important updates for the 2021 tax year and changes in 2022 that owners, partners, and shareholders of pass-through entities should consider before the start of tax season. To help clients, prospects, and others, Klatzkin has provided a summary of the key details below.

What is New Jersey BAIT?

Typically, the income, expenses, profits, and losses from pass-through entities (PTEs) flow through to owners, partners, or shareholders (“owners”). In New Jersey, PTEs can elect an entity-level tax treatment called the Business Alternative Income Tax, or BAIT. It was first enacted for the 2020 tax year.

BAIT is assessed based on the total of each owner’s prorated shares, or distributive proceeds. The entity pays the tax, not the individual, and individuals can then claim a refundable tax credit based on their amount of distributive proceeds. It’s an optional annual election, and PTEs must register with New Jersey’s Division of Revenue and Enterprise Services online.

If elected, PTEs would need to add the tax back to entity-level income on their annual tax return. Currently, 21 states have a similar PTE-level tax, including neighboring New York. Pennsylvania still assesses PTE taxes on an individual owner level. If a New Jersey PTE has a non-resident owner who lives in a state that has a similar entity-level tax, that owner can claim a tax credit for any PTE tax imposed on a partnership or S-corporation.

For 2020 and 2021, the BAIT rate varies according to a PTE’s distributive proceeds. The tax rate starts at 5.675 percent on the first $250,000 and goes up to 10.9 percent for distributive proceeds over $5 million.

Single-member LLCs and sole proprietors are ineligible for BAIT and the election cannot be made retroactively. The deadlines to make the election are either June 15 or March 31, depending on whether the entity has a fiscal year-end or calendar year-end, respectively. If a PTE elects BAIT, it cannot use other state tax credits to lower its tax liability.

Updates to 2021

There are four key updates to the 2021 BAIT tax return, Form PTE-100. They relate to:

• Distributive Proceeds
• Credit Forward
• Consolidated Return
• Estimated Payments and Installment Interest

When BAIT was first enacted, New Jersey calculated the tax base, or distributive proceeds, using federal taxable income. Because of this, starting in 2021, New Jersey PTEs will need to adjust their federal taxable income to calculate the state distributive proceeds.

This is different from the 2020 tax year when BAIT could have been over- or underpaid because the state tax base wasn’t factored in. This change is meant to more accurately assess owners’ tax liability.

Considering potential tax overpayments, starting in 2021 PTEs can apply excess taxes paid to the next taxable year. In 2020, a carryforward wasn’t permitted. This resulted in many PTEs waiting for large refunds in the midst of making 2021 estimated tax payments. To apply a carryforward, PTEs must first make the BAIT election for the subsequent year.

And, starting in 2021, Form PTE-100 has the option to file on a consolidated basis. This means that a group of PTEs can choose one entity from which to file a single return. Consolidated PTEs must be under common ownership, where an individual, estate, or trust (or a related group) owns more than 50 percent of direct or indirect voting control over each PTE. Even if one designated entity files BAIT on behalf of a group, each PTE must still file its own Form PTE-100, then check the box to indicate it is a member of a consolidated group.

Also new in 2021, PTEs must attach Schedule PTE-160, Underpayment of Estimated Pass-Through Business Alternative Income Tax to their annual tax return if there is interest due on a tax underpayment or if there’s an exception to how the interest was applied. PTEs without prior year tax liability will not be penalized for failure to file or make estimated tax payments.

Finally, S-corporations and partnerships can choose whether to calculate BAIT according to a single-sales factor or an equal three-factor apportionment. If choosing the latter, PTEs must attach an allocation schedule to their annual return.

Changes to BAIT for 2022

BAIT underwent changes for the 2022 tax year to modify the original tax structure. New Jersey PTEs should use these new rules when finalizing their 2022 state tax liability.

First, resident PTE owners will be required to include all income in the BAIT calculation, inclusive of out-of-state and foreign income. This applies to individuals, estates, and trusts. The hope is that residents would see a greater tax benefit paying at the entity level when reporting all income sources. However, S-corporation owners will continue to use only state income for the BAIT calculation.

There is another change concerning the BAIT treatment for residents versus nonresidents. Starting in 2022, PTEs do not have to withhold state gross income tax on nonresidents if the nonresident owner expects to receive a refund due to their BAIT credit. This would require proactive and regular tax planning throughout the tax year, especially if the PTE has substantially more income in one quarter than may have been initially projected.

The tax rates are also changing. While the top rate of 10.9 percent remains the same, it is now applied to income above $1 million. This replaces the rate that was the next level down, 9.12 percent on income between $1 million and $5 million.

Beginning in 2022, S-corporations will be required to calculate distributive proceeds using the three-factor apportionment method. Partnerships will calculate BAIT according to what’s included on their Form 1065.

Tax credits under BAIT also changed as follows.

• Individuals: refundable credit against gross income tax
• Estates or Trusts: refundable credit against gross income tax, which can be allocated to beneficiaries or applied to the estate or trust tax liability
• C-corporations: refundable credit against the surtax or corporation business tax (CBT)
  • C-corporations cannot amend 2020 or 2021 tax returns to reflect any additional refunds of the BAIT credit.
• S-corporations: refundable credit against gross income tax, which is allocated to shareholders or a refundable credit against the entity’s tax liability and applied to the surtax, CBT, nonconsenting shareholder payments, or the BAIT
  • S-corporations cannot amend 2020 or 2021 tax returns to reflect any additional refunds of the BAIT credit.
• Partnerships: refundable tax credit against gross income tax, which is allocated to partners or a refundable credit against the partnership’s tax liability that is applied against the nonresident partner tax, filing fees, or the BAIT

Contact Us

The state is currently in the process of releasing guidance for 2022 BAIT changes. Given the complexity of the BAIT program, it is important to consult with a qualified tax advisor to determine how your situation will be impacted. If you have questions about the information outlined above or need assistance with a tax or accounting issue, Klatzkin can help. For additional information call 609-890-9189 or click here to contact us. We look forward to speaking with you soon.

©2022 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date and should not be construed as accounting, tax, or financial advice. Please consult your tax advisor concerning your specific situation