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IRS-Proof? NJ Lawmakers’ Strategy to Preserve Small Business Tax Write-Off

Bipartisan legislators work to save thousands of small-business owners in New Jersey from being hit hard by GOP tax changes

sarlo tax plan
Sen. Paul Sarlo discusses the latest plan to offset tax hikes relating to the GOP tax-code overhaul. Looking on, L to R, are Sens. Troy Singleton, Steve Oroho, and Anthony Bucco.

Four state senators have devised a new strategy to save one group of New Jerseyans from the worst effects of the recently enacted GOP tax rules.

With thousands of small-business owners and members of business partnerships in New Jersey facing larger tax bills thanks to the federal tax changes that President Donald Trump signed into law late last year, a bipartisan group of state lawmakers is working on a remedy to preserve those businesses’ full tax write-off. (The new cap on a longstanding write-off for state and local taxes — which will stick many New Jersey homeowners with bigger tax bills — has received most of the attention in the wake of the federal tax changes.)

The senators outlined for the first time yesterday their effort to have the state reclassify income earned by those involved in New Jersey-based partnerships, limited-liability corporations and so-called S corporations, businesses that are often referred to as “pass-through” entities.

The reclassification would help those individuals — an estimated 266,000 — get around a new $10,000 limit that’s been placed on the federal write-off for state and local taxes known as SALT primarily because there is no such cap for taxes paid by businesses. Officials have been pursuing a similar tax-policy change in Connecticut, another state where taxpayers and small-business owners are facing higher taxes thanks to the new limit on the SALT deduction.

Keeping New Jersey competitive

“We’re going to respond and make sure that New Jersey continues to be competitive, and increases its competitiveness against our neighboring states,” said Sen. Steve Oroho (R-Sussex) during a news conference in the State House yesterday.

While a New Jersey bill is still being drafted, the proposal has already been endorsed by the New Jersey Society of Certified Public Accountants, and it is getting early praise from a key state business group. The effort will complement a piece of legislation that’s already been cleared by the full state Senate that is aimed at easing the loss of the full SALT deduction for property taxpayers with contributions made to municipal charitable funds, and it could also help lessen the impact of a millionaire’s tax championed by Gov. Phil Murphy for some small-business owners.

The federal tax changes that Trump signed into law just before Christmas slightly lowered individual income-tax rates and, among other changes, significantly cut the federal tax burden for corporations and those with large estates. To help pay for those cuts, the tax-code overhaul made several changes to rules related to federal tax exemptions and deductions.

While several analyses of the tax changes indicate many New Jersey residents could see some modest relief as a result of the overhaul, many others who itemize their deductions are likely to see an increase due, in part, to the new, $10,000 cap on the SALT deduction. Small-businesses and other pass-through entities are facing the same problem in New Jersey because they generally pay their state taxes through the personal income-tax code instead of the corporate code.

Remedy is for pass-through entities

To remedy the loss of a full SALT deduction for the pass-through entities in New Jersey, the lawmakers said the state could begin to tax them at the entity level instead of taxing the profits of each individual through the state income tax. The change would take advantage of the full deduction remaining in place for businesses, and the lawmakers said it would virtually recreate the way the state handled such entities in the early 1990s, before policymakers decided to switch to the current tax structure.

While questions remain about the legality of the SALT workaround involving charitable funds that’s been proposed for homeowners even as it has already worked its way through the Senate, the lawmakers said they are confident the bill aiming to help the pass-through entities will pass muster with the Internal Revenue Service because it was previously in effect for decades in New Jersey.

“Essentially, we’re going back to the future with a solution that is IRS-proof,” said Senate Budget and Appropriations Committee Chair Paul Sarlo (D-Bergen).

The lawmakers estimate the New Jersey pass-through entities generated roughly $23 billion in taxable income in 2015, but state tax statistics show the amount could be as high as $35 billion. That suggests the policy change has the potential to generate significant tax savings for those involved in the pass-through entities without changing how much money they will contribute in taxes to the state.

Hundreds of millions of dollars at stake

“We think that this idea could save New Jersey business owners hundreds of millions of dollars, and it’s not going to cost New Jersey anything,” said Jeffrey Kaszerman, director of government relations for the New Jersey Society of Certified Public Accountants. “You really can’t beat that.”

Kaszerman’s organization has been far more skeptical about the lawmakers’ proposal to get around the SALT for homeowners using the proposed charitable funds, with a recent membership poll finding 70 percent of the respondents have doubts that it would comply with existing IRS rules. But Kaszerman said the proposed workaround for the pass-through entities came right from one of their groups own members.

“We really look forward to continuing to work with (the lawmakers) to try and reduce the tax burden in New Jersey,” he said.

The proposal also won an early blessing yesterday from the New Jersey State Chamber of Commerce, with executive vice president Michael Egenton highlighting the bipartisan backing of the pending legislation. “I think it’s very positive,” Egenton said.

Meanwhile, with Murphy continuing to stick to a campaign promise to increase taxes on New Jersey millionaires to bring in more money for priorities like K-12 education, a reclassification of pass-through profits would likely mean those entities that would be subject to the higher rate would be able to write off their full state income-tax liability under the proposed legislation. That could at least soften the blow of a state tax increase for those entities since they wouldn’t be subject to the federal government’s $10,000 cap on the SALT deduction for individuals. Still, with Murphy due to present his first budget to lawmakers on March 13, Egenton suggested his organization remains on alert about any increase in the state’s top-end income-tax rate.

“That part of it we still have concerns about,” he said.

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