SALT Workaround for Small Businesses in NJ Misses the Boat

Bipartisan measure was supposed to reclassify state taxes for those with ‘pass-through’ entities. It was OK’d by the state Senate but was never posted for a vote in the full Assembly

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Business people
A bipartisan bill that would have restored a full federal SALT deduction for many New Jersey small businesses didn’t cross the finish line before this month’s tax-filing deadline, delaying potentially significant savings by at least a year.

The measure was designed to help residents who have what are known as “pass-through” entities, including partnerships, limited-liability corporations and so-called S corporations, by allowing them to reclassify their state taxes in a way that would make them fully deductible under federal law.

It wouldn’t have cost the state any revenue, according to the Legislature’s nonpartisan fiscal analysts, but the potential annual savings for the businesses were estimated by accountants to be as high as $800 million.

The legislation cleared the full state Senate in a unanimous vote late last year but didn’t make it out of the Assembly in time to take effect for the 2018 tax year. It’s unclear what will happen next; advocates for the policy change are now hoping to see it enacted in time for 2019 tax filings.

Known as the pass-through workaround, the bill was the second big piece of legislation drafted by state lawmakers in response to the major federal tax changes that President Donald Trump signed into law just before Christmas in 2017. While those tax cuts lowered personal income and corporate rates, Trump and the then-Republican Congress altered the rules for many federal tax exemptions and deductions to help pay for them. Among them was a capping of the longstanding SALT write-off for state and local taxes at $10,000.

Feds versus New Jersey

To help New Jersey homeowners cope with the new limit, Gov. Phil Murphy worked with lawmakers last year to enact legislation that sought to shift the classification of local taxpayer contributions that fund things like K-12 schools and municipal law enforcement from property taxes to charitable contributions. But that policy change, which attempted to take advantage of the full federal deduction that is still allowed for charitable contributions, has been bogged down in an ongoing dispute between the federal Treasury and New Jersey.

The proposed SALT workaround for small businesses and the owners of other pass-through entities involves changing state tax policy to take advantage of a full write-off for state and local taxes that is still available for businesses under the new federal tax code. To do so, the bill would establish a new “business-entity tax” in New Jersey for members of partnerships, limited-liability corporations and S corporations that are based here.

A tax rate of 5.525 percent would be levied on pass-through income totaling up to $250,000 in a given tax year; 6.37 percent on income totaling more than $250,000 but less than $1 million; 8.97 percent on income totaling more than $1 million but less than $3 million; and 10.75 percent on any income above $3 million, according to the bill.

Businesses would not be forced to use the new tax rule if it eventually becomes law, but those that do would receive a tax credit against their gross income-tax liability to ensure they are not double-taxed. Tax experts have suggested the pass-through workaround is on much safer ground than the one enacted for homeowners, and it was supported by the New Jersey Society of Certified Public Accountants and other business groups during legislative hearings. A similar measure has also been enacted in Connecticut, another state hit hard by the cap on the SALT deduction.

‘Revenue neutral’

Meanwhile, a fiscal estimate for the New Jersey bill prepared by the nonpartisan Office of Legislative Services determined the policy change would be “revenue neutral” for the state because the design of the new tax would not affect the total amount of revenue that New Jersey would collect from the pass-through entities. Any impact on the state would be limited to the cost of administering the new business-tax classification, the analysis said.

The bill passed the Senate 40-0 in December, and it also cleared the Assembly Appropriations Committee earlier this year in a 9-0 vote. But it was never posted for a vote in the full Assembly, meaning it didn’t make it to the governor’s desk in time to have an impact on filings for tax year 2018. Because the original bill sought to have the change in place for the 2018 tax year, it will likely have to be amended.

Pressed to explain why it has been held up, a legislative source yesterday suggested amendments may be in the works and blamed the Trump administration’s ongoing challenge of the homeowner workaround.

“The bill represents complicated changes to tax law that we want to make sure we get right since it will likely be scrutinized by a Trump-led IRS that rejected several other proposed SALT workarounds,” the source said.