State lawmakers believe there’s a way to help small-business owners get around a Trump change to the federal tax code that hits them hard. It could benefit as many as 270,000 New Jerseyans.

Lawmakers rushed into action earlier this year to help New Jersey homeowners deal with the loss of the federal SALT write-off, and now they’re turning their attention to assisting the state’s small-business owners.

Bipartisan legislation that the state Senate is expected to approve today would help preserve the full deduction for state and local taxes for some small-business owners. These are residents who have what are known as “pass-through” entities, including partnerships, limited-liability corporations and so-called S corporations.

It would help a group of roughly 270,000 residents get around the $10,000 limit on the federal SALT deduction that President Donald Trump and the Republican Congress capped as a write-off.

To remedy the loss of a full SALT deduction for the pass-through entities, the proposed legislation would see the state begin to tax them as a business entity instead of taxing the profits that individuals make through their businesses via the state’s personal-income tax. The sponsors say they are merely re-establishing the way the state handled the taxing of such entities in the early 1990s, before policymakers decided to switch to the current tax system.

“This plan works because the federal tax plan allows businesses to continue to deduct all of their taxes,” said Sen. Steve Oroho (R-Sussex), a bill sponsor who is also a certified financial planner.

Could preserve full deductibility of $23 billion a year

According to the bill, which underwent some amendments after its unveiling earlier this year, the state will levy the newly classified business tax on “income, dividends, and gain received from the pass-through business.”

Gov. Phil Murphy worked with lawmakers earlier this year to enact a similar workaround for homeowners who are also facing the same limit using proposed local-government charitable funds. But while the workaround for homeowners remains the subject of an ongoing dispute between the federal Treasury and New Jersey, tax experts have suggested the legal foundation for the proposed pass-through workaround is on more stable ground. If it proves successful, the bill sponsors calculate the pass-through income reclassification could preserve the full deductibility of a combined $23 billion in annual income based on an analysis of 2015 tax data.

“This legislation doesn’t solve the whole problem created by a federal tax law that targets New Jersey by sharply curtailing the federal deduction for State and Local Taxes,” said Senate Budget and Appropriations Committee Chair Paul Sarlo (D-Bergen). “But we are going to do everything we can to help New Jersey taxpayers.”

The federal tax changes that Trump signed into law just before Christmas last year 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 $10,000 cap on the SALT deduction, which was previously unlimited. Many owners of 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.

A rate of 5.525 percent will 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 that is more than $3 million, according to the bill.

Voluntary measure

Just as the state’s new homeowner workaround is voluntary in nature, New Jersey businesses would not be forced to use the new tax rule. Those that do would receive a tax credit against their gross income tax liability to ensure they are not double-taxed.

The new tax rule would be backdated to the beginning of the year, meaning it will apply to the full 2018 tax year once signed into law by Murphy, who has been a vocal critic of the federal tax changes. And unlike the homeowner workaround — which was flagged as questionable by the New Jersey Society of Certified Public Accountants — this one has the group’s full blessing and was crafted with its input.

Meanwhile, a fiscal-impact analysis prepared by the nonpartisan Office of Legislative Services indicated the legislation would be “revenue neutral” for the state because the design of the tax change is not expected to impact the total amount of taxes that New Jersey will collect from the pass-through entities.

The analysis also highlighted a way the tax change could boost the state’s budget flexibility by reclassifying the revenue from pass-through entities as business-tax proceeds instead of personal-income collections. Under the state constitution, all revenue collected from the income tax is dedicated to providing property-tax relief, while all other income flows into the state’s unencumbered general fund. But state Treasurer Elizabeth Maher Muoio has been warning lawmakers that a series of tax cuts enacted in recent years has strained the general fund as it has lost major sources of revenue like the estate tax and seen a reduced sales tax also cut into the overall revenue stream.

“To the extent that pass-through entities elect to pay the pass-through entity alternative business tax, the revenue will shift from the Property Tax Relief Fund to the General Fund,” the OLS analysis said.

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