As part of New Jersey’s (NJ or the State) annual budget negotiations, the State has enacted a series of important tax changes which impact the corporation business tax (CBT), the corporate income tax imposed by New Jersey on C corporations conducting business in the State.
Governor Murphy signed Assembly Bill No. 5323 on July 3, 2023, after several months of negotiations between the governor’s office, legislative leaders, and impacted interest groups. This piece of legislation represents the third attempt at reforming the CBT in the last five years.
Background for CBT Changes
Assembly Bill No. 5323, as enacted, makes a series of important changes to New Jersey’s CBT. Many of these changes are aimed at clarifying and correcting issues associated with the State’s adoption of unitary combined reporting in tax year 2019.
Unitary combined reporting refers to a state tax reporting method which mandates that commonly-owned and controlled corporations engaged in a unitary business report income and loss on a group-wide basis. A unitary business is generally a single common business enterprise comprised of multiple corporations or divisions that contribute value to one another by sharing of resources, officers and management, personnel, funds, intellectual property, etc.
New Jersey’s combined reporting rules generally have three different reporting groups that are possible:
- A water’s edge group: A water’s edge reporting group consists of all corporations incorporated in the U.S. (unless 80 percent or more of the corporation’s property and payroll are based outside the U.S.) which are engaged in a unitary business and foreign corporations with 20 percent or more of their property and payroll based in the U.S. and engaged in the same unitary business. Water’s edge reporting is the default method, while the other methods must be elected.
- A world-wide group: A world-wide group includes all unitary business member’s income/loss regardless of place of incorporation or location of property and payroll.
- An affiliated group: An affiliated group includes all corporations incorporated in the U.S. which are engaged in a unitary business and part of an affiliated group as defined in Internal Revenue Code (IRC) section 1504.
Both the world-wide and affiliated group reporting methods require an election to be made by the designated reporting entity.
Important CBT Changes
- Changing the apportionment calculation for a combined group: Under the Division of Taxation (the Division) policy, a water’s edge combined group apportions the combined group’s income by only taking into account the receipts of members who have nexus with New Jersey when computing the receipts factor numerator. This is referred to as the Joyce method of apportionment.
Beginning in tax years ending on or after July 31, 2023, the opposite method is adopted—meaning that all combined group members’ New Jersey-source receipts should be included in the receipts factor numerator, regardless of whether the entities generating the receipts have independent nexus with New Jersey. This is referred to as the Finnigan method of apportionment.
- Adoption of bright-line nexus threshold: Since 2002, the CBT has been imposed on corporations for simply deriving income from the State, but without a dollar or transaction amount specified in the law, often referred to as a bright-line threshold following the U.S. Supreme Court’s decision in Wayfair v. South Dakota, 585 U.S. ___ 138 S. Ct. 2080; 201 L. Ed. 2d 403 (2018).
Beginning in tax years ending on or after July 31, 2023—the CBT will now adopt a bright-line nexus threshold of $100,000 in New Jersey source receipts or 200 separate transactions for purposes of imposing the corporate level tax. The legislation also clarifies that the adoption of this bright-line threshold does not preclude the Division from asserting nexus based on other constitutional law standards where these thresholds may not be satisfied.
- 80 percent net operating loss limitation and interaction with the dividends-received deduction: Beginning in tax years ending on or after July 31, 2023, CBT taxpayers will be limited to a net operating loss (NOL) deduction equal to 80 percent of taxable income. Additionally, the State’s Dividends-Received Deduction (DRD) will now be applied before the NOL deduction. Historically, the statute called for NOLs to be utilized prior to the DRD—causing NOLs to be absorbed by dividends that were ultimately excluded from the tax base.
- Restoring the DRD to 100 percent: For the 2019-2022 tax years, the DRD was reduced from 100 percent to 95 percent for dividend recipients owning 80 percent or more of the subsidiary paying the dividend. This legislation restores this DRD back to 100 percent but does call for an add back of related dividend expenses, which are construed to equal five percent of all dividends received by the taxpayer during the tax year in question.
- Reclassifying GILTI: For periods on or after July 31, 2023, amounts included as Global Intangible Low-Taxed Income (GILTI) under IRC section 951A should be treated as dividends and thus, potentially eligible for the DRD.
- Computation of worldwide income: The tax law clarifies that non-U.S. entities should report effectively connected income and exclude treaty-exempt income from the starting point for computing entire net income in the context of a CBT return that is not reporting income on a worldwide combined basis. When there is a worldwide combined reporting group, exclusions pursuant to U.S. income tax treaties will not apply under the new law.
- Tax periods open for adjustment when claiming NOL carryforwards: Prior to recent case law, the Division’s historical audit policy was that tax periods that are beyond the four-year statute of limitations are open for adjustment when NOL carryforwards are claimed from those closed periods. However, in R.O.P. Aviation, Inc. v. Director, Division of Taxation, 32 N.J. Tax 346 (N.J. Tax Ct. 2021), the New Jersey Tax Court disagreed and held that a taxpayer’s NOL carryovers could not be adjusted to the extent generated in years that are outside the statute of limitations.
For privilege periods ending July 31, 2022 or later, the legislation permits the Division (as well as the taxpayer) to adjust NOLs for up to 10 years after initially reported on the taxpayer’s CBT-100 return.
- Codification of the Division’s policy on IRC Section163(j): The legislation also codifies current Division policy which treats a combined group return as one single return with taxpayers, making adjustments pursuant to IRC section 163(j) as though they had been included on a single federal consolidated return.
- Sharing of prior NOLs: When combined reporting was initially adopted, New Jersey also shifted from allowing NOLs to be computed on a pre-apportioned basis to a post-apportioned basis. As a result, losses generated prior to that change needed to be converted to post-apportioned NOLs, otherwise known as prior NOL conversion carryovers (PNOLs). Under the original combined reporting legislation, PNOLs could only be utilized by the entity which originally generated the loss. The new legislation revises this policy and allows for sharing of PNOLs among members of a combined reporting group.
- Repeal of related-party interest and intangible add-back rules: Prior to 2019, the New Jersey CBT was imposed and reported on a separate-entity basis. Accordingly, as part of the Business Tax Reform Act of 2002, the State enacted related-party interest and intangible expense add-back rules for purposes of computing net income to try and prevent improper income-shifting between related entities. These rules and their exceptions were convoluted and the subject of several court cases in New Jersey.
Beginning in tax periods ending or after July 31, 2023—these add-back rules are repealed and the combined reporting rules already call for intercompany transactions to effectively be eliminated.
These tax changes are significant and can have incredibly differing tax impacts and ramifications depending on entity-type, ownership structure, and sources of income and deductions/losses. It is imperative that you and your tax advisors take these legislative changes into account when planning, making estimated payments and entering into various transactions that may implicate these tax policy and computation changes. Should you have any questions, please contact Jaime Reichardt at firstname.lastname@example.org.
For information on additional changes to New Jersey's taxes, including the Gross Income Tax, read more here.
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