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Tax Alert

August 2002

New Jersey’s Business Tax Reform Act Makes Major Changes to the State’s Taxation of Business Entities

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ew Jersey Governor James E. McGreevey recently signed into law Assembly Bill 2501, designated the Business Tax Reform Act (the “Act”). The Act makes major changes to New Jersey’s Corporation Business Tax (“CBT”) and other changes that, together, will affect nearly every entity doing business in the State. Most changes increase the level of entity tax; the Act is expected to add more than $1 billion per year to the State’s tax revenues and was a key component of the Governor’s plan to eliminate the State’s budget

• deficit. Most provisions of the Act are effective

immediately, for taxable years beginning in 2002. The changes to the business tax are numerous and complex. Brief summaries of the chief revisions follow.

Corporate Alternative Minimum Assessment

The new corporate Alternative Minimum Assessment (AMA) will apply to all corporations with an “economic presence” in New Jersey, except New Jersey S corporations, professional corporations, investment companies, and “cooperatives” meeting certain requirements. Currently, certain foreign corporations are not subject to the CBT because federal law precludes any state from assessing an income tax on income earned by a foreign corporation from the taxing state, if the corporation’s activities within that state are negligible. Because the AMA is not an income tax, New Jersey has announced that the AMA will permit the State to assess a fair level of tax on foreign corporations that currently “exploit the State’s marketplace,” but are exempted from the CBT by federal law. A corporation’s AMA will be determined using a formula based either on gross receipts allocable to New Jersey or on gross profits (defined as gross receipts less cost of goods sold) allocable to New Jersey, the choice between the two methods at the election of the taxpayer corporation. (Any election must stand for five taxable years before it can be changed.) The availability of the gross profits option is designed to avoid assessing an unfairly high level of tax on high-gross/ low-margin companies such as retailers. Businesses with gross profits of $1 million or less or gross receipts of $2 million or less are not subject to the AMA. Companies subject to the CBT will calculate their tax liabilities under both the AMA and the CBT and pay the greater of the two. Those not subject to the CBT will pay the AMA. The AMA is scheduled to sunset (expire) for tax years beginning after June 30, 2006, but it will remain in place after that date for foreign corporations not subject to the CBT.

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This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. 65 Livingston Avenue www.lowenstein.com

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Roseland, New Jersey 07068-1791 Telephone 973.597.2500 Fax 973.597.2400

Additional Changes to CBT to Increase Revenue

Disallow Deduction For Expenses Paid to Affiliates

The Act disallows the deduction of many expenses when payments for such expenses are made to related parties. The State asserts that affiliated groups had employed such payments and deductions to shift income to states with low or no income taxes. The following expenses no longer are deductible under most circumstances:

• Interest paid to a related party; and
• Royalties and other intangible expenses

paid to affiliates.

Partially Disallow Dividends Received Exclusion

Before the Act, a corporate taxpayer could exclude all or a portion of dividends it received from other corporations, including subsidiaries. Under the Act, a corporation may continue to exclude 100% of dividends received if they are paid by a subsidiary in which the taxpayer corporation has at least an 80% ownership interest. It may exclude 50% of dividends received if they are paid by a subsidiary in which the taxpayer corporation has at least a 50% (but less than 80%) ownership

• interest. Dividends received from corporations in

which the taxpayer corporation has less than a 50%

• wnership interest are not excludable.

Throwout Rule

New Jersey businesses with sales to states in which they are not subject to tax (so-called “nowhere sales”) will pay a higher level of tax to New Jersey under the Act. Prior to the effectiveness of the Act, tax paid to New Jersey was based on a sales factor derived by dividing sales made in New Jersey by total sales, including nowhere sales. The Act removes the nowhere sales from the denominator of the sales factor fraction, resulting in tax being paid to New Jersey on a higher proportion of income.

New Minimum Corporation Business Tax

Prior to enactment of the Act, the CBT imposed an annual minimum tax of $200 on both domestic corporations and on foreign corporations “doing business” in New Jersey. The Act replaces that minimum with a CBT annual minimum of (i) $2,000 for any corporation affiliated with a group that has an annual payroll of $5 million or more; and (ii) $500 for all other foreign corporations doing business in New Jersey and all other domestic

• corporations. Note that the annual minimum tax

applies (as did the $200 minimum) to all domestic corporations, whether or not those domestic corporations actively conduct business during the year.

New Filing Fees For Partnerships, LLCs, and Professional Corporations

The Act establishes new “filing fees” for entities treated as partnerships for federal income tax purposes (except those listed on a national stock exchange), including general and limited partnerships, limited liability companies, and limited liability partnerships. Partnerships that have income from New Jersey sources and more than two members will be required to pay an annual $150 per-owner filing fee, based on the number of K-1s filed with the State, capped at $250,000 per entity annually.

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The Act establishes a similar filing fee of $150 per licensed professional for professional corporations that derive income from New Jersey sources and are comprised of more than two licensed professionals. The professional corporation filing fees are also capped at $250,000 per entity annually. Each entity required to pay filing fees for taxable year 2002 must at the time they are due make an additional payment of 50% of the amount due as an installment payment toward the following year’s fees.

Payments on Behalf of Partners and LLC Members

In addition to the filing fees, each partnership (other than a qualified investment partnership and a partnership listed on a national stock exchange) that has income from New Jersey sources must make a prepayment of income tax on behalf of each non-resident noncorporate partner (much like a withholding payment). The payment will be credited proportionally (with respect to share of net income and a special multiplier) to the separate accounts of the nonresident partners.

Other Changes

• For 2002 and 2003, corporate net
• perating loss carryover deductions are

suspended (and their expiration periods tolled). In addition, net operating losses may no longer be carried over by a taxpayer that changes its state of incorporation.

• S corporation tax rates, which are in the

third year of a promised four-year-long complete phase-out, will be reset to the 2001 level and frozen. They will remain frozen at the 2001 level through tax year 2005. After 2005, the phase-out is due to resume.

• In a concession to the smallest

businesses, the CBT rate for corporations with net income of $50,000 or less will be reduced from 7.5% to 6.5%.

Conclusion

The Act also establishes a Corporation Business Tax Study Commission, ensuring that there will be further discussion, publicity, and

• changes. The changes thus far have been

sweeping; this Alert highlights only the general contours and provisions of the Act. To discuss how the Act may affect you and your business entity, please call your Lowenstein Sandler tax advisor at 973.597.2500.

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