Oct 02 Tax Alert: FAQs Released on Business Alternative Income Tax (BAIT)

On Tuesday, September 29, the Division of Taxation released guidance on the recently enacted Business Alternative Income Tax (BAIT) in the form of an FAQ page on its website.  While BAIT was initiated at the beginning of this year, guidance on the administration of the tax had been paused since early March.

The BAIT is an elective tax regime, effective for tax years beginning on or after January 1, 2020,  whereby qualifying pass-through business entities may elect to pay tax at the entity level.  This is designed to create deductible tax expense for federal tax purposes, serving as a work-around for the state and local tax deduction limitations.  BAIT paid by the electing pass-through entity can then be claimed as a credit on the returns of the members.

The FAQs confirm some important understandings of the new tax regime:

• The election to be taxed under this regime is a yearly election due on or before the original due date of the return (e.g., March 15, 2021 for 2020 calendar-year taxpayers).
• Entities eligible to make this election include partnerships, Federal S Corporations with valid NJ S Corporation elections, and multi-member LLCs.
• Single member LLCs and sole proprietorships are not eligible to make this election.
• Electing entities will not be penalized for failure to make estimated payments for the 2020 tax year.

Further, the Division has enabled online estimated payments of 2020 BAIT.  Although estimated payments are not required at this time,  cash-basis taxpayers who plan to take advantage of the state and local tax (SALT) deduction on their 2020 federal income tax return, should make the BAIT estimated payments by December 31, 2020.

The BAIT is calculated based on the entity’s income sourced to New Jersey, with a graduated tax rate ranging from 5.675% (for income under $250,000) to 10.9% (for income over $5,000,000).  The FAQs illustrate the mechanics of the BAIT in the following example:

Pass-through entity AB has 2 New Jersey resident members with total income of $1,500,000 that is 60% sourced to New Jersey resulting in New Jersey sourced income of $900,000.  Each are 50% members. The distributive proceeds (sourced to New Jersey) are allocated $450,000 to Member A and $450,000 to Member B.

Tax is imposed on the sum of each member’s share of distributive proceeds, which is $900,000. Using the graduated tax schedule tax on $900,000 would be $56,567.50.  Each New Jersey resident member’s share of the entity level tax equals ($56,567.50*50%) = $28,283.75.

Each member can  use the BAIT credit to offset their member-level tax liabilities.  Individuals can request a refund to the extent the credit exceeds their individual liabilities.  Corporate members can carryforward any excess credit to future periods.

The FAQs also explicitly state that the Division will allow a resident taxpayer credit for the Connecticut pass-through entity tax against their gross income tax liability.  Without explicitly stating this, it was uncertain if the tax paid at the pass-through entity level to Connecticut was  creditable to its individual members in New Jersey.  That same uncertainty is present for New Jersey non-residents in entities electing to pay the BAIT.  Would a New York resident member in an entity paying the BAIT be allowed a credit on their New York tax return for their share of the BAIT paid to New Jersey?  That is uncertain. By explicitly stating New Jersey will allow credits for similar tax regimes (e.g., Connecticut), the Division appears to be inviting other states to offer similar consideration for their residents.

For more information on BAIT and other current state and local tax issues, join our webinar, COVID-19 Impact on State and Local Taxes on Tuesday, October 6 @ 2pm by registering here.