Significant NJ Tax Changes Announced

Over the last few months, the State of New Jersey has been considering making significant changes to state tax rules. The focus has been on overhauling the business tax code to make it more competitive with other states. As expected, earlier this month Governor Murphy signed Assembly Bill (AB) 5323 into law. It calls for several changes to the state tax code, including an update to nexus rules, decoupling from federal R&D amortization requirements, NOL adjustments, and updates to business interest deduction rules. To help clients, prospects, and others, understand the changes and related impact, Klatzkin has provided a summary of the key details below.

Retroactive Provisions

IRC Section 163(j) Interest Deduction

The IRC Section 163(j) interest deduction limitation places limits on how much business interest expense a taxpayer can deduct, based on adjusted taxable income (ATI) and the amount of business interest income received. This retroactive provision means that the limitation needs to be computed on a federal consolidated basis, which would be calculated as if all affiliated entities were included in a single consolidated federal return.

However, if members of a New Jersey combined group are affiliates not included in the federal consolidated return, then the IRC Section 163(j) interest deduction limitation must be calculated based on the New Jersey combined group, which is the unit of taxation for state purposes.

Tax years beginning January 1, 2022

Decoupling from IRC Section 174 amortization requirement

The IRC Section 174 amortization requirement made some significant changes to how research and development (R&D) expenditures are deducted. Specifically, taxpayers can no longer immediately deduct expenses but are now required to capitalize and amortize these expenses. The new provision decouples New Jersey from the federal rules. This means that current-year deductions can be made for expenses that happened during the same privilege period as when a New Jersey R&D credit is claimed.

Tax years ending on or after July 31, 2022

NOL Adjustments Statute of Limitations

The new provisions allow for Net Operating Losses (NOLs) to be adjusted in closed years, extending the statute of limitations to 10 total years. Either the New Jersey Director of Taxation or the taxpayer can adjust these NOLs that were claimed in closed years. This can be done to determine the proper tax liability in years that are still covered by this new statute of limitations.

Worldwide Filing Requirements

Members of an affiliated business group now have worldwide filing requirements.  Income from all sources, both domestic and foreign, should now be filed on a single tax return. Foreign affiliates that are part of an affiliated group or water’s edge filing will be included to the extent of effectively connected income (ECI). This is the part of the foreign affiliate’s income that is determined as being earned in New Jersey.

Tax years beginning on or after January 1, 2023

Single Sales Factor Sourcing for Partnerships

Single sales factor sourcing apportions income to a state based on the in-state total sales. With this change, the Division of Taxation will shortly be releasing updated tax forms and instructions for taxpayers. Single sales factor sourcing can be contrasted with three-factor apportionment, which takes into account the payroll and property of the taxpayer in the state as well.

Sales of services will now be sourced to New Jersey using market-based sourcing. In market-based sourcing, the sales of services are attributed to a state based on where the service was received. This can be compared to origin-based sourcing, where sales are sourced based on the state where the service was performed.

While the provision is retroactively applicable to January 1, 2023, estimated tax penalties and interest will not accrue for any underpayments of tax due if additional estimated payments are made no later than the “second next estimated payment due following the enactment…or the second estimated payment due after January 1, 2024, whichever due date is later” for tax periods ending on and after July 31, 2023.

Current and Future Provisions – Tax years on or after July 31, 2023

CBT Return Filing Deadline

New Jersey returns for corporate business taxes (CBT) will now be due on the 15th day of the month following the original federal filing due date. This would mean that for April 15 due dates on federal taxes, New Jersey returns will be due on May 15.

Economic Nexus Threshold

Under this new ruling, a corporation will be subject to CBT if it has more than 200 separate transactions to customers in New Jersey or if it has receipts in the state that exceed $100,000. These provisions are now similar to how New Jersey handles sales and use tax in determining whether an entity has a sufficient connection to the state in order to be taxed.

Sales Factor Sourcing

Even if the member doesn’t have nexus with New Jersey, as determined by this new threshold, sales factor now abides by the “Finnigan” apportionment method and not the “Joyce” rule.

The Finnigan rule is more inclusive than the Joyce rule, stating that all New Jersey-sourced receipts from combined group members need to be added to the receipts factor numerator. A combined group includes any group of corporations that are treated as a single entity for tax purposes. Even if a combined group doesn’t have a physical presence or established nexus in New Jersey, it still needs to report in the apportionment calculation the receipts that come from New Jersey.

Global Intangible Low-Taxed Income

Global intangible low-taxed income (GILTI) is earned by US multinational corporations from intangible assets. These can include things like copyrights, trademarks, and patents. Now, income that is categorized as GILTI income will be treated as a dividend, which means it will be eligible for the 95% dividends received exclusion. This exclusion means that only 5% of dividends are subject to taxation.

NOL Conformity

Under IRC Section 172, New Jersey is now conforming to the 80% limitation on net operating losses (NOLs). The provision limits the amount of NOLs that a taxpayer can deduct against their taxable income. Combined group members can now share NOL and prior NOL (PNOL) carryforwards, even if they were not created as part of a combined filing. This may allow combined groups to pool their NOL or PNOL carryforwards and use them more efficiently, limiting their tax liability and offsetting their taxable income.

Tax years on or after January 1, 2024

The 2.5% CBT surtax will sunset on December 31, 2023.

Assembly Bill 4694 and Convenience of the Employer Test

Governor Murphy also signed Assembly Bill 4694 on July 21, 2023. This bill introduces a convenience of the employer test for residents of New Jersey.  With this bill, employers would need to withhold New Jersey income tax for employees if the following conditions are met:

• The individual taxpayers do not live in New Jersey.
• They are earning wages from a New Jersey employer.
• The services are performed outside of New Jersey, but that service location is not required.
• The state of residence of the worker is one that imposes a “convenience of the employer test” – New York, Pennsylvania, Nebraska, Connecticut, or Delaware.

If these are all satisfied, the employer would withhold New Jersey income tax even though the employee doesn’t work in New Jersey.

New Jersey residents who are subject to the convenience of the employer test in another state and successfully protest a denial by another state or jurisdiction of a refund for taxes paid on income derived from services rendered in New Jersey can also receive a credit equal to 50% of the refund owed to New Jersey as a result of the readjustment. This will apply to tax years beginning on or after January 1, 2020, through December 31, 2023.

Contact Us

The significant number of changes made to the New Jersey tax code will certainly create new saving opportunities. However, there are certainly questions and issues that will arise in navigating the changes. If you have questions about the information outlined above or need assistance with a state 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.