—Background—
This law establishes an alternative business income calculation under the gross income tax (GIT) allowing taxpayers to offset income from one type of business with losses from another. The law also permits taxpayers to carry forward business-related losses for a period of up to 20 taxable years.
This law is designed to bring New Jersey’s small business taxation into the 21st century. The gross income tax was adopted in 1976. A goal of the 1976 act was simplification. The law eschewed the complex deductions, exclusions, carry-forwards, carry-backs, phase-outs, credits, and special allowances of the federal income tax. Instead, taxable income was simply the sum of separately defined income categories. However, losses from any one category could not offset income from another.
Since 1976, new forms of business entities have emerged and small businesses are most commonly organized as pass through entities (LLCs, partnerships, S-corporations). The inability to cross-net income, (gains or losses from one business income category to another) has served as a deterrent for business growth and development. The new law grants a limited offset among specified categories of business-related income.
The new law also gives New Jersey business income taxpayers the ability to carry-forward business income losses for up to 20 years, the same standard found in the Corporate Business Taxpayers (CBT). Under prior law, gross income taxpayers were not permitted to carry-forward losses to offset tax liabilities in future tax years, as is allowed for corporate business taxpayers.
—Change in the Law—
The new law reforms the taxation of business income for owners of pass through businesses such as LLCs, partnerships, S-corporations, and sole proprietors. It amends the GIT for business taxpayers by establishing an alternative business income calculation that allows the limited use of losses in one category of business income to offset gains in another category. The alternative business income calculation will be used beginning in tax year 2012. Also, beginning in 2012, business losses can be carried forward for up to 20 years.
Under the new law, there are four categories of business income within the 16 income related categories under the GIT that can be netted:
- net profits from business;
- net gains or net income derived from or in the form of rents, royalties, patents, and copyrights;
- distributive share of partnership income; and
- net pro-rata share of S-corporations.
The alternative business income calculation consists of the following steps:
- Calculate income from the four aforementioned categories as you would under the prior law. That is, losses in one income category cannot offset gains in another income category. The result would be called “regular business ”
- Calculate “alternative business income” under the new model allowing for consolidation and loss carry-forwards. Under alternative business income, losses in one category can offset gains in another income category within those four categories mentioned
- Then subtract “alternative business income” from “regular business income.” The result is called the “business ”
- Multiply the business increment by the percentage allowed under the law. Beginning in tax year 2012, taxpayers will be able to subtract specific percentages of their “business increment” from taxable income for immediate tax relief. The percentages are outlined below.
The percentage phase-in schedule for tax relief is: 10 percent of the business increment in 2012; 20 percent of the business increment in 2013; 30 percent of the business increment in 2014; 40 percent of the business increment in 2015; and 50 percent of the business increment in 2016 and thereafter. Finally, if one is left with a loss in calculating business income, that loss may be carried forward and applied to offset future income for up to 20 years.
—How Will This Affect My Business?—
If you have multiple forms of business income such as net profits from business; net gains or net income derived from or in the form of rents, royalties, patents, and copyrights; distributive share of partnership income; and/or net pro-rata share of S-corporation income, taxpayers can potentially lower their taxable income and their tax liability using the new alternative business income calculation. Furthermore, the law now allows unused net losses to be carried forward for up to 20 years under the GIT.
While the change is not a straight-forward tax cut, it does provide some tax relief. NJBIA urges taxpayers to consult a tax professional when attempting to calculate tax liability under the new law.
—For More Information—
The Division of Taxation has posted a helpful explanation of the new law at http://www.state.nj.us/treasury/taxation/pdf/nettingnotice.pdf. The explanation includes several examples illustrating the new calculation.
If you need additional information, please contact Andrew Musick at 609-393-7707, ext. 9512, or via e-mail at amusick@njbia.org or James B. Evans, Jr. at 856-874-7139, or via e-mail jbe@kulzerdipadova.com.
Updated: December 18, 2017
This information should not be construed as constituting specific legal advice. It is intended to provide general information about this subject and general compliance strategies. For specific legal advice, NJBIA strongly recommends members consult with their attorney.
