January 2003

New Jersey Tax Legislation Will Have Substantial Impact on Businesses
Effective for Tax Years Beginning in 2002

By Joseph A. Pacello

New Jersey Gov. James McGreevey signed into law the Business Tax Reform Act on July 2, 2002, enacting major changes to the state’s corporate business tax (CBT). The centerpiece of the new law is the Alternative Minimum Assessment (AMA), which is imposed on a corporation’s gross income. The act also includes changes affecting unincorporated businesses such as partnerships and LLCs. The act is effective retroactively to Jan. 1, 2002.

Alternative Minimum Assessment

For tax years beginning on or after Jan. 1, 2002, corporations must pay the greater of the regular CBT or the AMA, up to a maximum of $5 million. The assessment is based on either New Jersey–allocated gross receipts or New Jersey–allocated gross profits (which takes into account cost of goods sold), depending on which method is elected by the corporation. High-volume, low-margin industries will likely elect to use the gross profits method. Whichever method is elected must be used for five years.

The first $2 million of gross receipts and $1 million of gross profits are exempt from the AMA. Certain types of entities are exempt entirely from the assessment, including S corporations, professional corporations, and pass-through entities. (Note that the latter two are subject to new filing fees, discussed below.)

The AMA is scheduled to sunset in 2006, except for taxpayers who benefit from Public Law 86-272, unless they waive their rights under that statute, which protects out-of-state corporations that engage in certain limited activities in the state.

Higher Corporate Minimum Taxes

The act increased the annual minimum tax from $200 to $500 for tax years beginning in 2002. Corporations that are members of affiliated or controlled groups (based on federal rules) with total payrolls of $5 million or more will be subject to a minimum tax of $2,000.

Partnership Tax Payments

For tax years beginning on or after Jan. 1, 2002, partnerships and entities treated as partnerships (i.e., LLCs) must make tax payments to New Jersey based on the amount of their New Jersey–source income that is allocable to nonresident partners. The tax is payable by the due date of the return (excluding extensions) and is credited to the New Jersey tax accounts of the nonresident partners, similar to withholding.

There are exemptions for certain types of partnerships, such as “qualified investment partnerships,” which, among other requirements, must have more than 10 partners, none of which own more than a 50 percent interest. There also is a limited exclusion for hedge funds that meet some but not all of the criteria for qualified status.

Filing Fees

The act imposes a $150 per-owner processing fee on partnerships, and a similar fee on professional corporations, based on the number of licensed professionals.

The partnership fee is imposed on partnerships that have more than two partners and income derived from New Jersey sources. The fee, capped at $250,000, is assessed based on the number of K-1s issued and is payable by the due date of the partnership’s return (excluding extensions). The payment also must include an additional 50 percent installment payment toward the next year’s fee.

The professional corporation fee, imposed on CPAs, attorneys and other professionals, is similar to the partnership fee, except that it is imposed based on the number of licensed professionals employed by the corporation, using a quarterly average, which is then multiplied by $150. The fee is imposed only on licenses related to the corporation’s business.

Other Provisions

The act contains a number of other provisions, most of which are intended to raise revenue and/or close perceived loopholes. These provisions include:

• Suspension of net operating loss (NOL) carryforward deductions for 2002 and 2003.
• Acceleration of quarterly estimated tax payments for large corporations.
• “Decoupling” from federal bonus depreciation.
• Disallowance of deductions between related parties for expenses such as interest and royalties.
• Disallowance of deductions for foreign taxes.
• Modification of income apportionment rules for New Jersey companies that make sales to states where they are not subject to tax (“nowhere sales”); such sales will be subject to a “throw-out” rule. Other modifications to the apportionment rules include a customer-based sourcing rule for broker-dealers and asset management companies.

Conclusion

The business reform act enacted sweeping changes to the way corporations and other business entities are subject to tax in New Jersey. Practitioners need to be aware of these changes, and ensure that proper planning and analysis is done to minimize clients’ exposure to them. In light of the budget shortfall the state is facing, the New Jersey Division of Taxation is expected to be fairly aggressive in enforcing these new rules.

Regulations under the act were expected to be issued sometime in late December.

Answers to frequently asked questions about the act can be found on the New Jersey Division of Taxation’s web page at www.state.nj.us/treasury/taxation/cbtfaq.htm.

Highlights of the act can be found on the New Jersey State Legislature’s web page at
www.njleg.state.nj.us/2002/Bills/A3000/2501_S2.HTM.