The legislation, known as the “Pass-Through Business Alternative Income Tax Act,” was approved by the full Senate by a 40-0 vote on Monday.
It is designed to protect so-called pass-through businesses and partnerships that pay taxes through their owners’ personal income returns rather than the state or federal corporate taxes from the federal law’s new $10,000 cap on deductions for state and local taxes.
TRENTON — New Jersey senators used their final voting session of 2018 to advance legislation intended to protect thousands of small businesses in the state from possible tax hikes caused by the federal tax overhaul.
The legislation, known as the “Pass-Through Business Alternative Income Tax Act,” was approved by the full Senate by a 40-0 vote on Monday. It is designed to protect so-called pass-through businesses and partnerships that pay taxes through their owners’ personal income returns rather than the state or federal corporate taxes from the federal law’s new $10,000 cap on deductions for state and local taxes.
The cap is likely the most controversial component of the new tax law in New Jersey and other high-tax states because it limits how much residents can write off from their state income and property taxes.
In order to protect pass-through businesses, which have previously been able to deduct all their state and local taxes in their owners’ federal returns, the legislation would reclassify those businesses’ income tax payment as an “elective entity-level tax” rather than personal income.
By doing so, those businesses will be able to write off the state income tax payment because the federal tax law’s $10,000 cap does not apply to business taxes.
Based on the most recent IRS statistics, the proposal is expected to protect some 260,000 individuals and families in New Jersey that reported some $23 billion in income from pass-through businesses and partnerships.
“Small business operators deserve tax laws that provide fairness and don’t negatively impact their bottom line,” said Sen. Troy Singleton, D-7th of Delran, who was one of the measure’s bipartisan co-sponsors.
“This legislation will help to defray the out-of-pocket income tax hit for small business owners here in New Jersey and help alleviate the inequities created by the federal tax law,” Singleton said.
The legislation is the latest move by New Jersey lawmakers to try to blunt the impact of the federal tax law’s cap on how much can be deducted for state and local taxes.
Earlier this year, Gov. Phil Murphy signed into law legislation allowing towns, counties and other local governments to establish charitable funds that homeowners can contribute to in return for property tax credits equal to 90 percent of what they gave.
The funds are intended to be used to pay for government services normally funded by property taxes, and homeowners who contribute were expected to be able to write off the full amount of those contributions on their federal tax returns because the new tax law kept in place an uncapped deduction for charitable contributions.
In response to New Jersey’s and other states’ moves to create charitable contribution funds as a workaround to the tax law, the U.S. Treasury announced that the federal government would only permit taxpayers to deduct the amount they give to charitable funds minus whatever state or local tax credit they receive.
The one exemption would be if the tax credit was less than 15 percent the value of the donation. In those cases, the full contribution would be considered deductible.
Murphy and state Attorney General Gurbir Grewal have vowed to fight the Trump administration if it follows through with limiting New Jersey residents’ ability to write off charitable contributions toward government services. The state has already joined litigation with other high-tax states challenging the constitutionality of the cap itself, arguing that it was created to punish Democratic-controlled states like New Jersey.
So far, no Burlington County towns are believed to have moved forward with creating the charitable funds though.
Unlike the charitable contributions workaround, state Sen. Paul Sarlo, D-36th of Wood-Ridge, said the proposed workaround for pass-through businesses in the state was “IRS-proof” because New Jersey previously taxed pass-through businesses the same way until 1993.
Because the businesses’ tax rates would remain the same as the personal income tax rates, there also would be no loss of revenue to the state.
“We’re going ‘Back to the Future’ with an IRS-proof solution,” said Sarlo, chairman of the Senate Budget and Appropriations Committee and the prime sponsor of the legislation. “It will return to a tax system that was in place for decades. 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. But we are going to do everything we can to help New Jersey taxpayers.”
Sen. Steve Oroho, R-24th of Franklin, said the measure would save “hundreds of millions” for many New Jersey businesses registered as S corporations, as well as LLCs such as law firms, medical groups and accounting firms.
“This plan works because the federal tax plan allows businesses to continue to deduct all of their taxes,” he said.
The legislation is pending in the Assembly, where it is sponsored by Assemblymen Dan Benson, D-14th of Hamilton, and Anthony Bucco, R-25th of Boonton.