On July 21, 2023, New Jersey’s (NJ or the State) Governor Phil Murphy signed Assembly Bill 4694 (enacted as P.L. 2023, c.125) which makes a series of important changes to NJ’s gross income tax (GIT) including adopting a convenience of the employer rule, a new tax credit for residents who may be unfairly taxed by other states, and a new grant program.
Earlier in the month, Governor Murphy signed Assembly Bill No. 5323 (enacted as P.L. 2023, c.96) which mostly impacted the state’s corporate income tax but did include one very significant change for GIT purposes related to how a nonresident partner or sole proprietor determines their New Jersey source income.
The GIT is the personal income tax imposed by the State on residents and nonresidents earning income from the State. Below is a description of the new GIT changes from both bills with context and commentary.
Apportionment and sourcing changes for nonresident partners and sole proprietors
For GIT purposes, the New Jersey Division of Taxation (the Division) has historically called for an evenly weighted three-factor apportionment formula consisting of a property, payroll, and receipts factors for purposes of apportioning partnership and sole proprietor income to New Jersey for nonresidents. Under this method, receipts from services are sourced based on where the service is performed. For S corporations, however, single receipts factor apportionment is utilized with receipts from services sourced to where the customer receives the benefit of the service, a method otherwise known as market sourcing.
Effective for tax years ending on or after July 31, 2023, all nonresident pass-through entity owners, regardless of business entity type (S corporation, partnership, sole proprietor), will apportion net business income to New Jersey using a single receipts factor and market sourcing. Accordingly, nonresident partners and business owners of entities based outside New Jersey with large amounts of New Jersey sales could see their total New Jersey GIT liabilities increase. Conversely, nonresident taxpayers that own entities largely based in New Jersey, but without significant New Jersey source receipts, could see their GIT liabilities decrease.
Note: This change allows the GIT to treat all business entities in the same manner when it comes to apportionment and sourcing. It also corrects the difference in taxable income computations for GIT versus nonresident withholding, which has relied on single factor apportionment and market sourcing since 2019.
One important issue that is not addressed by the legislation is the potential difference in tax base computations for GIT purposes as opposed to the tax base calculation for the New Jersey elective pass-through entity tax (PTET). The New Jersey PTET statute defines the apportionable tax base (for nonresident partners and S corporations) by reference to a prior GIT statute which calls for the Division’s director to promulgate regulations that provide for a method of apportionment or allocation of income. Historically, that method has been three-factor apportionment with receipts from services sourced based on the location of performance. The new law revising the apportionment and sourcing method for partnerships with nonresident partners was codified in the legislation as a new section of the GIT code. Therefore, it is not clear whether the new apportionment and sourcing regime will apply for purposes of the PTET. This potential difference could cause large disparities between NJ PTET paid by an electing entity and total GIT due on the pass-through entity owner’s individual return.
Background on the convenience of the employer rule
The convenience of the employer rule (COE Rule) is a state personal income tax rule which generally provides that when a nonresident taxpayer is assigned to or employed by an in-state employer, but works remotely from a location outside the state in question due to convenience and not job necessity—the state of the employer may impose income tax on their compensation. Even if a predominate amount of the work is performed in another state, a jurisdiction with a COE rule may impose income tax on the compensation if the choice in work location is based on the employee’s convenience.
States with a broad convenience of the employer rule include, among others, Connecticut, Delaware, Nebraska, New York (NYS), and Pennsylvania. There are also some states which temporarily apply COE Rule principles in seeking to tax income earned from remote work during the COVID-19 pandemic work-from-home orders, such as Massachusetts.
As related to NJ, NYS has aggressively applied the COE Rule for decades against employees telecommuting from neighboring states, such as NJ. NYS’s aggressive policy has a significant cost to NJ GIT revenue since the State grants residents a credit for any income tax paid to NYS under the COE Rule to prevent double taxation.
NJ COE Rule and New Tax Credit
P.L. 2023, c.125 attempts to address this significant tax issue in two ways:
- Adopting a NJ COE Rule for tax year beginning in 2023; and
- Creating a tax credit for successfully challenging another state’s imposition of the COE Rule.
Specifically, when a nonresident of NJ works for an NJ employer and works remotely due to their own convenience, NJ will apply a COE Rule to source the compensation to NJ and impose GIT if they are a resident of a state that also applies a COE Rule. This change will take effect for tax year 2023.
Additionally, the new law creates a refundable GIT credit available to residents of NJ that successfully obtain a final judgment from another state’s tax court or tribunal resulting in the NJ resident being refunded taxes paid to that state or jurisdiction on the basis that the income was derived from services performed in NJ. The GIT credit would be equal to 50 percent of the amount of GIT owed to NJ as a result of the readjustment of the resident credit for tax paid to another state to account for the reduction of tax/refund from the other state.
Note: The COE Rule adopted by New Jersey is similar to the approach taken by Connecticut which imposes the COE Rule only in situations where the taxpayer’s state of residence imposes a similar COE Rule. The new refundable tax credit is a unique approach to encourage resident taxpayers to file for refund claims with CEO rule states and pursue appeals until successful. To date, we have not seen a similar statute or regulation employed elsewhere.
Procedural Change for Adjusting the Resident Credit for Tax Paid
The GIT resident credit statute is amended to provide that a resident taxpayer must file a claim for refund on account of increasing the resident credit for tax paid to another state upon any change or audit by another state by the later of: (1) one year following notification of the additional other state tax being due; or (2) the usual three year statute of limitations.
This represents a limitation on the previous rule which gave an unlimited amount of time to readjust the resident credit, provided that the resident taxpayer initially claimed such a credit on their original GIT return. Interestingly, the NJ Division of Taxation still has an unlimited amount of time to adjust a taxpayer’s resident credit on account of less tax being due to another state.
Note: This new limitation is important for taxpayers to bear in mind when conducting business in or earning income from multiple states. If additional tax is found to be due to another state, the taxpayer will have one year from the date of notification or three years from the filing of their original GIT return to adjust their resident credit and claim a refund. This new law seems to run afoul of the NJ Taxpayer Bill of Rights, which calls for equal treatment among taxpayers and the NJ Division of Taxation. This is generally why the time limitation for filing a refund claim matches the time limitation for the State to make an additional assessment of tax, absent certain circumstances or facts like fraud or gross omissions of income.
Importantly, many other jurisdictions in the U.S. do not have such an extended statutory period for claiming a refund or filing an amended return to account for an increase in tax due to another state. Accordingly, taxpayers dealing with income tax audits or voluntary disclosures in non-resident states where the tax due has not been determined in final must protect their statutory rights. Accordingly, these taxpayers should strongly consider filing protective refund claims or amended returns if they reside in jurisdictions that do not provide an extended period for amending the credit for tax paid to another state. Fortunately, New Jersey has dealt with this problem in the new legislation; but this is still a major problem in many other states and localities across the U.S.
New Grant Program for Reassigning Employees to New Jersey Locations
P.L. 2023, c.125 establishes a pilot program, to be administered by the NJ Economic Development Authority (EDA), that will provide grants to businesses to assign their NJ resident employees to NJ locations. A business is eligible for the grant if the business has 25 or more full-time employees and is principally located in another State. The grant amount equals the lesser of: (1) NJ income tax withholdings from the eligible employees; or (2) $500,000. The EDA may establish preferences in awarding grants based on capital investment made by the applicant or a plan to pay additional compensation or bonuses to the employees being relocated to NJ.
The law caps the sum of all grants awarded in any fiscal year at $35 million. The bill requires grant applications to be filed on or before July 1, 2028.
These new GIT changes collectively alter the landscape for GIT planning, compliance, employer reporting and potential controversy issues in a very significant way. Please reach out to Citrin Cooperman’s State and Local Tax Practice should you have any questions on the above items or have clients with any of the issues implicated in this publication.
For information on additional changes to New Jersey's taxes, including the Corporation Business Tax, read more here.
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