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Alternative Surtax and Decoupling Bill Passed by New Jersey Legislature, Sent to Governor

The New Jersey Legislature passed an initial bill that would:

  • impose a surtax on corporations for two years;
  • decouple from certain provisions of the federal Tax Cuts and Jobs Act;
  • reduce the dividend exclusion;
  • impose a tax on certain dividends; and
  • clarify treat provisions.

If enacted, the bill would take effect immediately and apply as noted below.

The bill has been sent to Gov. Phil Murphy. However, the governor has threatened to veto the bill.

Surtax on Corporations

The bill would impose a surtax on a corporation’s allocated net income. The surtax would be equal to:

  • 2.5% if the corporation has entire net income between $1 million and $25 million; or
  • 4% if the corporation has entire net income over $25 million.

The surtax applies for only two years. The first year is the tax year ending on or after January 1, 2018. The second year is the next tax year.

Business incentive credits would not apply against the surtax. However, the bill would allow credits for:

  • installment payments;
  • estimated payments made with a request for an extension of time for filing a return; or
  • overpayments from prior tax years.

The surtax would not apply to public utilities.

Nonconformity with Federal Tax Reform Provisions

The starting point for computing New Jersey’s corporate income tax is federal taxable income. The federal Tax Cuts and Jobs Act of 2017 made numerous changes that affect a corporation’s federal taxable income. New Jersey generally follows federal law, unless a specific adjustment to federal taxable income is required.

With respect to the Tax Cuts and Jobs Act, the bill would create New Jersey corporate income tax adjustments that:

  • disallow federal deductions against the repatriation (transition) tax on accumulated foreign earnings (IRC Sec. 965);
  • disallow the 20% deduction for qualified business income from a pass-through entity (IRC Sec. 199A); and
  • apply the interest deduction limitation (IRC Sec. 163(j)) on a pro-rata basis to interest paid to both related and unrelated parties.

The adjustment for IRC Sec. 965 would apply to tax years beginning after 2016. The adjustments for IRC Sec. 199A and IRC Sec. 163(j) would apply to tax years beginning after 2017.

Dividend Exclusion

The bill would reduce the dividend exclusion amount for taxpayers receiving dividends from an 80% or greater owned subsidiary. The exclusion goes from 100% to 95% of the dividends included in federal taxable income.

This change applies to tax years beginning after 2018.

Dividends Tax

The bill would impose a 9% tax on dividends a corporation receives from subsidiaries. The tax would apply to dividends actually paid, deemed dividends, and all other distributions treated as dividends. In addition, the total amount of dividends received would have to be greater than $1 million.

To determine its tax liability, a corporation would use an allocation factor based on:

  • New Jersey gross domestic product; over
  • total U.S. gross domestic product.

A credit would be available for the amount of franchise tax paid, if any, on the same dividends.

The tax would not be deemed a tax on capital stock or property. It also would not be subject to the addback for taxes paid.

Insurance companies would also owe the tax.

The tax would only apply to tax years beginning after 2016 and ending before 2019. It would have to be paid by May 15, 2019.

Treaty Provisions

Finally, the bill would clarify that New Jersey “entire net income” is generally determined without treaty-based federal:

  • exclusions;
  • exemptions;
  • deductions; or
  • credits.

An exception would exist if they are expressly made applicable to states under the treaty. The New Jersey Legislature passed a second income tax bill that would:

  • impose a surtax on corporations;
  • decouple from certain provisions of the federal Tax Cuts and Jobs Act; and
  • reduce the dividend exclusion.

A second bill was passed by the legislature.  Although similar, the two bills are not identical.

In addition, the second bill is tied to the first. In fact, the second bill would actually amend the first bill and only take effect if the first bill is enacted.

The second bill would also repeal or supersede provisions in the first bill that:

  • impose a tax on certain dividends; and
  • clarify treat provisions.

Surtax on Corporations

The first bill would impose a surtax on a corporation’s allocated net income. The second bill would change the type of income used to determine the surtax rate. Instead of “entire net income,” the second bill would use “allocated net income.”

As a result, if the second bill is enacted, the surtax would be equal to:

  • 2.5% if the corporation has allocated net income between $1 million and $25 million; or
  • 4% if the corporation has allocated net income over $25 million.

All other surtax provisions from the first bill would still apply.

Nonconformity with Federal Tax Reform Provisions

With respect to the Tax Cuts and Jobs Act, the first bill would create state income tax adjustments that:

  • disallow federal deductions against the repatriation (transition) tax on accumulated foreign earnings (IRC Sec. 965);
  • disallow the 20% deduction for qualified business income from a pass-through entity (IRC Sec. 199A); and
  • apply the interest deduction limitation (IRC Sec. 163(j)) on a pro-rata basis to interest paid to both related and unrelated parties.

For the pass-through income deduction, the second bill would still decouple from federal law for corporation income tax purposes. However, unlike the first bill, it would not do so for gross (personal) income taxes too.

The second bill would still apply the interest deduction limitation on a pro-rata basis. However, it would use a slightly different approach than the first bill. In the first bill, the pro-rata application applies regardless of whether the related parties are subject to an addback. This provision is not found in the second bill. Instead, in the second bill, any interest that is not allowed as a deduction would be excluded from the calculation.

The provisions in the first bill concerning the repatriation (transition) tax would not be affected by the second bill.

Dividend Exclusion

Both bills would reduce the dividend exclusion amount for taxpayers receiving dividends from an 80% or greater owned subsidiary. However, the second bill would do this is two stages, while the first bill would do it in one.

In the first bill, the exclusion goes from 100% to 95% for tax years beginning after 2018.

In the second bill, the exclusion first goes from 100% to 90% for tax years beginning in 2017. Then, for tax years beginning after 2017, the 95% exclusion rate applies.

Dividend Tax

The first bill includes a new 9% tax on dividends a corporation receives from subsidiaries. However, the second bill would repeal the tax.

Treaties

The first bill also includes provisions clarifying the effect of treaties on New Jersey “entire net income.” The second bill would remove these provisions from state law.

If you have any questions or if you would like more information, contact Fred Schutz at (856) 722-5300 ext. 201 or Dave Gill at ext. 210.