WILL YOU TAKE THE “BAIT?” By JASON ROSENBERG, CPA WITHUM
A national trend ensuing the Tax Cuts and Jobs Act (TCJA) has been states’ attempts to circumvent the $10,000 state and local tax (SALT) deduction limitation. New Jersey is one of the latest states to enact such a SALT workaround, using an entity-level tax known as the Pass-Through Business Alternative Income Tax (BAIT).
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The SALT limitation has profoundly impacted mid-market businesses. As these businesses predominantly use “passthrough” entities (PTE) in structuring their affairs, businesses were awarded with cuts to their marginal tax rates, but in many cases these tax cuts were nullified by the inability to continue to deduct SALT. Pass-through businesses are generally not subject to an entity-level tax. Conversely, the profits flow through to the owners and, as such, are taxed under the individual income tax regime. In hightaxed states, many owners of pass-through businesses, such as partnerships, limited liability companies and S corporations, found themselves with an increased tax burden, or, at best, a reduced net benefit. It’s been repeatedly reported in the news that the TCJA SALT limitation brought for the first time in over 100 years the inability for taxpayers to deduct SALT. As such, this results in taxes on income that in effect are being double taxed at the federal and state levels. States previously operated under the long-standing precedent that the federal code provides for deductibility. Some states, including New Jersey, contribute significantly more taxes to the federal government than they receive back in federal spending, according to “Giving or Getting,” a January 2020 report from the Rockefeller Institute of Government. Also, statutory deductions and credits are not adjusted in states with higher costs of living. The pre-TCJA SALT deduction counterbalanced some of these inequities. As a result, many states have been scurrying around in conjunction with research policy institutes attempting to devise legislation to overcome the impact of the TCJA to its constituents. Most notably, a
JANUARY/FEBRUARY 2021 | NEW JERSEY CPA
number of states have enacted legislation using PTEs in an attempt to mitigate the SALT limitation impact. The entity-level tax at the PTE attempts to sidestep the SALT limitation by shifting state taxes from the individual to the PTE, allowing the owners to claim a credit on their state tax return for the owner’s distributive share of taxes paid by the PTE. To date, a number of states have enacted PTE SALT workarounds. New Jersey’s PTE workaround has received a lot of attention as it is one of the highest-taxed states in the nation. ENTICING BUSINESSES WITH NEW JERSEY “BAIT” The pass-through income tax, or BAIT, applies to tax years beginning on Jan. 1, 2020, and provides PTEs the opportunity to alleviate the effects of the SALT limitation. The annual election allows PTEs to elect to pay tax due on the owner’s share of distributive proceeds at the entity level; the owners may then claim a tax credit for the amount of tax paid by the pass-through
