On July 3, 2023, New Jersey Gov. Phil Murphy signed major tax legislation, A.B. 5323, which makes significant changes to the Corporation Business Tax (CBT) regime.1 The most noteworthy CBT amendments include establishing bright-line economic nexus standards, requiring certain captive entities to file in a combined group with their owners, altering the tax treatment of global intangible low-taxed income (GILTI) and foreign derived intangible income (FDII), decoupling from the federal treatment of research and experimental (R&E) expenditures under IRC Sec. 174 in certain cases, changing the treatment of net operating losses (NOLs) and prior NOL conversion carryovers, and adopting the Finnigan method for unitary combined group apportionment. Also, the legislation amends the gross income tax to require the use of CBT sourcing provisions in certain situations.
Bright-line economic nexus adopted
For taxable years ending on and after July 31, 2023, a corporation deriving receipts from sources within New Jersey is deemed to have substantial nexus and is subject to the CBT if it meets either of the following criteria during its fiscal or calendar year: (i) derives receipts from sources within New Jersey in excess of $100,000; or (ii) has 200 or more separate transactions delivered to customers in New Jersey.2 This provision does not preclude a corporation from having nexus with New Jersey if the corporation’s exercise of its franchise in the state is otherwise sufficient for New Jersey to impose CBT as allowed by the U.S. and New Jersey Constitutions and laws. Also, this provision does not prevent a corporation from owing the statutory minimum tax if a corporation has nexus with New Jersey and is otherwise protected from tax based on income under Public Law 86-272.3
Worldwide combined groups
For privilege periods ending on and after July 31, 2022, a worldwide group must include all members of the combined group, wherever located or formed.4 The combined group must include all the income and attributes of those members regardless of how or whether those members file federal returns or report or include their income in federal taxable income, and without regard to any exemption or exclusion from federal taxable income under the terms of a tax treaty. However, any federal deductions that also are allowed under the CBT that would apply to a U.S. corporation, but that a non-U.S. corporation is prohibited from claiming for federal income tax purposes because the income was not included in federal taxable income or because the corporation is a non-U.S. corporation, are allowed for the non-U.S. corporation members for CBT purposes as though they were U.S. corporations.5
Foreign corporations and treaty protection
For privilege periods ending on and after July 31, 2022, for a corporation incorporated or formed in a foreign nation with a comprehensive tax treaty with the U.S., and that is not a member of a worldwide combined reporting group, entire net income does not include items of income or loss excluded or exempted from federal taxable income under the terms of the treaty.6 Deductions, exclusions or eliminations are not permitted for any excluded income or loss. For a non-U.S. corporation that files a federal return and is not a member of a combined group filing a New Jersey combined return on a worldwide basis, the non-U.S. corporation only includes its income or loss included in federal taxable income, which is limited to the non-U.S. corporation’s effectively connected income or loss.7
Inclusion of certain captive entities in combined groups
For privilege periods ending on and after July 31, 2023, certain captive real estate investment trusts (REITs), regulated investment companies (RICs) and investment companies (ICs) are included in combined groups and taxed in the same manner as C corporations.8 The legislation does exclude certain captive entities that are owned by smaller banks from inclusion in combined groups. For example, a captive REIT9 does not include a company of which at least 50% of the shares is owned or controlled by a state or federally chartered bank, savings bank, or savings and loan association with assets that do not exceed $15 billion.10 Similar definitions are provided for captive RICs and ICs.11
Treatment of GILTI and FDII changed
For privilege periods and taxable years ending on and after July 31, 2023, the statute adopting the federal provision allowing a 50% deduction for GILTI and a 37.5% deduction for FDII is repealed.12 As a result, 100% of FDII is subject to CBT. Because a statute is amended to specify that GILTI13 is considered a dividend for CBT purposes,14 GILTI will now be treated in the same manner as other dividend income. New statutory language provides that entire net income excludes 100% of dividends and deemed dividends that were included in federal taxable income and paid by subsidiaries owned 80% or more by the taxpayer.15 Existing law excludes 50% of dividends or deemed dividends if paid by a subsidiary that is owned at least 50%, but less than 80% by the taxpayer.16
Dividend exclusion and clawback
The exclusion for dividends and deemed dividends is increased from 95% to 100% for dividends that are paid by subsidiaries that are at least 80% owned by the taxpayer.17 The existing post-allocation dividend exclusion is replaced with a pre-allocation dividend exclusion.18 The amount of dividends and deemed dividends that is excluded is then reduced by 5% to reflect a deemed amount of attributable expenses and deductions.19
Decoupling from federal R&E treatment
Under IRC Sec. 174, prior to enactment of the Tax Cuts and Jobs Act of 2017 (TCJA),20 taxpayers were allowed the option to currently deduct R&E expenditures or treat such expenditures as deferred expenses to be capitalized and amortized over their life. As amended by the TCJA, for amounts paid or incurred in tax years beginning in 2022 and thereafter, all taxpayers are required to capitalize R&E expenditures over a five-year period for domestic expenses and 15 years for foreign expenses. The recent legislation expressly decouples from this treatment for privilege periods beginning on and after Jan. 1, 2022, allowing taxpayers in New Jersey to immediately deduct R&E expenditures for which a state research credit is claimed,21 notwithstanding the timing schedule required by IRC Sec. 174 for the deduction of specified R&E expenditures.22
Interest deduction limitation
For privilege periods ending on and after July 31, 2022, the interest deduction limitation under IRC Sec. 163(j) is applied to a combined group as though the combined group filed a federal consolidated return.23 Under existing law, for privilege periods beginning after Dec. 31, 2017 and ending before July 31, 2022, the interest deduction limitation under IRC Sec. 163(j) applies on a pro rata basis to interest paid to both related and unrelated parties, regardless of whether the related parties were subject to interest expense addback.24
Net operating losses
New Jersey’s NOL provisions traditionally have differed from federal law. However, for privilege periods ending on and after July 31, 2023, New Jersey adopts the federal NOL limitation under IRC Sec. 172(a)(2), but substitutes the dates provided in the section.25 As a result, an 80% limitation applies.
An NOL is defined by New Jersey law as the excess of the deductions over the gross income used in computing entire net income, without regard to any NOL carryover.26 For privilege periods ending on and after July 31, 2023, the NOL is computed after accounting for the deductions for international banking facilities and dividends received,27 allocated to New Jersey.28 Prior to amendment, the NOL was computed without accounting for these deductions.
New Jersey currently allows an NOL for any privilege period ending on or after July 31, 2019, to be carried forward for 20 years.29 For privilege periods ending on and after July 31, 2023, the portion of the loss that is carried forward is the excess of the loss over the sum of the entire net income, after the deductions for international banking facilities and dividends received30 are allocated to New Jersey.31
New provisions apply if a taxable member of a combined group has an NOL carryover from a loss incurred prior to the taxable member joining the group.32 For privilege periods ending on and after July 31, 2023, the carryover may: (i) be pooled with the combined group NOL carryover for use by the combined group; or (ii) be used by the taxable member that generated the carryover for that member’s activities that are independent of the unitary business of the combined group. However, the combined group and its members must use tracing protocols for all NOL carryovers.
For privilege periods ending on and after July 31, 2022, the Director of the Division of Taxation or a taxpayer may adjust NOLs in privilege periods closed for purposes of the statute of limitations on assessments to determine the correct tax liability in privilege periods that remain open to assessment.33
Prior NOL conversion carryover
In 2018, New Jersey enacted legislation making significant changes to the state’s CBT regime, including adopting mandatory combined reporting and changing the calculation of NOL deductions and carryovers from a pre-allocation to post-allocation basis for tax years ending on and after July 31, 2019.34 As part of this change, unused and unexpired NOL carryovers are converted from a pre-allocation NOL carryover to an allocated prior NOL conversion carryover (PNOLCC). As amended by the recent legislation, for privilege periods ending on and after July 31, 2023, the amount of the PNOLCC is subtracted from entire net income allocated to New Jersey, after the deductions for international banking facilities and dividends received35 against current privilege period income when the entire net income allocated to New Jersey is greater than zero.36
The remaining balance of PNOLCC deductions of the combined group members may be pooled together and allowed to offset the entire net income apportioned to New Jersey of either: (i) the combined group for which the corporation is a member; or (ii) the corporation that created the PNOLCC, provided the corporation departs the group before the corporation’s respective PNOLCC has been completely used.37 Under existing law, a PNOLCC deduction was allowed to offset only the entire net income allocated to New Jersey of the corporation that created the PNOLCC, and the PNOLCC could not be shared with other members of the combined group.38 For privilege periods ending before the members of a combined group pool their PNOLCC for use by the combined group, a member is allowed to sell PNOLCCs to other members of the group at an arm’s-length price.39
Net deferred tax liability deduction for combined groups
Following the enactment of combined reporting provisions in 2018, publicly traded companies were allowed a deduction40 for the aggregate increase to their net deferred tax liability or the aggregate decrease to their net deferred tax asset, or an aggregate change from a net deferred tax asset to a net deferred tax liability.41 For group privilege periods beginning in 2023 through 2029, the combined group may deduct 1% of the deduction amount during the group’s privilege period.42 For group privilege periods beginning in 2030 and thereafter, the combined group may deduct up to 5% of any remaining unused amount of the deduction during the group privilege period, until the total deduction amount is fully utilized.43 Prior to amendment, a combined group was allowed to deduct 10% of the deduction amount for 10 years for privilege periods beginning in 2023 through 2032.44 As a result of this legislation, the timing of the deduction is substantially lengthened.
Related-party addback repealed
For privilege periods and taxable years ending on and after July 31, 2023, the related-party addback statute is repealed.45 Under this statute, originally enacted when New Jersey required taxpayers to file on a separate reporting basis, taxpayers were required to add back otherwise deductible interest and intangible expenses directly or indirectly paid to one or more related members.
Apportionment factor for unitary combined groups adopts Finnigan method
For privilege periods and taxable years ending on or after July 31, 2023, New Jersey is changing from the Joyce to the Finnigan apportionment methodology for combined groups.46 Specifically, in computing a combined group’s numerator and denominator of the apportionment factor, the combined group, as one taxpayer, must include all unitary receipts of all members of the combined group.47 Previously, in computing the numerator, each taxable member of the group was treated as a separate taxpayer and that member’s numerator included only its receipts assigned to New Jersey.48
Gross income tax sourcing
For taxable years beginning in 2023 and thereafter, a taxpayer subject to gross income tax that engages in a trade or business, or is an owner of a partnership or S corporation, which conducts business within and outside New Jersey is required to source this income using CBT sourcing provisions to the extent that income from New Jersey sources cannot be readily or accurately ascertained.49 However, income that is the taxpayer’s salary or other remuneration is sourced using the gross income tax provisions.50
Commentary
This legislation is described by the New Jersey Department of the Treasury as “essentially revenue-neutral,” but it makes numerous significant changes to the CBT that will affect most corporate taxpayers in the state.51 As a result, taxpayers should carefully evaluate the numerous changes enacted by A.B. 5323, particularly as many of the law changes are becoming effective in the middle of a calendar year, while considering potential planning opportunities.
Because this legislation was enacted on July 3, 2023, it is a Q3 event for tax accounting purposes. The fact that several of the more significant changes apply to privilege periods ending on and after July 31, 2023 means that for many taxpayers (including calendar-year taxpayers), the changes are already in effect for their current tax year, with the potential need to prospectively adjust their estimated payments and provision posture to reflect these changes. On the positive side, the temporary 2.5% corporate surtax imposed on income over $1 million was not extended beyond Dec. 31, 2023.52 The changes to the tax treatment of GILTI should benefit many taxpayers by increasing the exclusion of this income.53 The characterization of GILTI as a dividend means that it will not be included in the numerator of the sales factor. Also, the amendments to the treatment of NOLs and PNOLCCs in which these tax attributes can be pooled by combined group members will increase the ability to use these attributes to offset income and could impact tax provisions and deferred tax assets. The decoupling from the federal treatment of R&E expenditures under IRC Sec. 174 allows taxpayers to immediately expense these costs.
Other changes may have a negative effect on some taxpayers. The adoption of the bright-line economic nexus standard for purposes of the CBT may provide more clarity on which entities are subject to New Jersey CBT, but it may result in additional entities being subject to tax. Because this nexus standard was created for sales and use tax purposes, there may be difficulties in applying this to an income tax context. Note that the $100,000 threshold is very low compared to the income tax economic nexus thresholds enacted in other states. Also, application of a transactional threshold to an income tax may be problematic. Furthermore, changing from a Joyce to Finnigan method for apportioning the income of combined unitary groups may increase the amount of income that is subject to the CBT.
Finally, while the taxation of captive REITs, RICs and ICs may substantially increase the tax liability of certain taxpayers required to file on a combined basis, the legislation is intended to preserve the separate reporting regime for certain captives owned by smaller banks.
1 Ch. 96 (A.B. 5323), Laws 2023.
2 A.B. 5323, § 6. For purposes of this provision, a service transaction is considered to be delivered to a customer where the benefit is received within the meaning of N.J. Rev. Stat. § 54:10A-6(B)(4). Note that the gross income tax does not use a bright-line nexus standard. A partnership is required to file an informational return if it has a: (i) New Jersey resident partner; or (ii) any income or loss derived from New Jersey sources. N.J. Admin. Code § 18:35-1.3(f)1.
3 Id. P.L. 86-272 is the 1959 federal law that limits the state taxation of income from sales of tangible personal property if the taxpayer’s only business activities in the state are the solicitation of orders that are approved and shipped from outside the state. 15 U.S.C. §§ 381-384.
4 N.J. Rev. Stat. § 54:10A-4(kk).
5 Id.
6 N.J. Rev. Stat. §§ 54:10A-4(k)(18)(A); 54:10A-4.6.b(2)(a).
7 N.J. Rev. Stat. §§ 54:10A-4(k)(18)(B); 54:10A-4.6.b(2)(b).
8 N.J. Rev. Stat. § 54:10A-4(hh), (ii), (jj).
9 A captive REIT is defined as a REIT that is not regularly traded on an established securities market and of which more than 50% of the voting stock is owned or controlled by a single entity that is treated as an association taxable as a corporation under the IRC, is not exempt from federal income tax, and is not a REIT. N.J. Rev. Stat. § 54:10A-4(ii).
10 N.J. Rev. Stat. § 54:10A-4(ii).
11 N.J. Rev. Stat. § 54:10A-4(hh), (jj).
12 A.B. 5323, § 14, repealing N.J. Rev. Stat. § 54:10A-4.15.
13 See IRC § 951A.
14 N.J. Rev. Stat. § 54:10A-4(k)(5)(G). For New Jersey apportionment purposes, the numerator of the sales factor does not include dividends that are excluded from net income. N.J. Rev. Stat. § 54:10A-6(B)(6).
15 N.J. Rev. Stat. § 54:10A-4(k)(5)(A)(iv). However, the 100% exclusion is reduced by 5% for expenses and deductions.
16 N.J. Rev. Stat. § 54:10A-4(k)(5)(B).
17 N.J. Rev. Stat. § 54:10A-4(k)(5)(A)(iii), (iv).
18 N.J. Rev. Stat. § 54:10A-4(k)(5)(F)(i). Specifically, the dividend exclusion is “deducted from entire net income after the State modifications that increase federal entire net income but before the other State modifications that reduce entire net income and before the allocation of entire net income to this State.” Note that New Jersey law uses the “allocation” terminology in place of “apportionment.”
19 N.J. Rev. Stat. § 54:10A-4(k)(5)(F)(ii). Due to this 5% reduction, the exclusion for dividends effectively remains 95%.
20 P.L. 115-97.
21 See N.J. Rev. Stat. § 54:10A-5.24.
22 N.J. Rev. Stat. § 54:10A-4(k)(11).
23 N.J. Rev. Stat. § 54:10A-4(k)(2)(K)(ii).
24 N.J. Rev. Stat. § 54:10A-4(k)(2)(K)(i).
25 N.J. Rev. Stat. § 54:10A-4(k)(2)(K)(i).
26 N.J. Rev. Stat. § 54:10A-4(v)(2).
27 N.J. Rev. Stat. § 54:10A-4(k)(4), (5).
28 N.J. Rev. Stat. § 54:10A-4(v)(2).
29 N.J. Rev. Stat. § 54:10A-4(v)(1).
30 N.J. Rev. Stat. § 54:10A-4(k)(4), (5).
31 N.J. Rev. Stat. § 54:10A-4(v)(1).
32 N.J. Rev. Stat. § 54:10A-4.6.h(3).
33 N.J. Rev. Stat. § 54:49-6.c. This legislation addresses R.O.P. Aviation, Inc. v. Director, Division of Taxation, N.J. Tax Court, No. 01323-2018, May 27, 2021. In this case, the court held that the Division of Taxation could not disallow NOLs generated in closed taxed years and carried forward to an open tax year under an audit examination. For further discussion of this case, see GT SALT Alert: New Jersey rules against closed-year NOL adjustment.
34 Ch. 48 (A.B. 4202) and Ch. 131 (A.B. 4495), Laws 2018. N.J. Rev. Stat. § 54:10A-4(u). For further information, see GT SALT Alert: New Jersey clarifies new net operating loss rules; Technical Bulletin TB-94(R), General Information on the New Net Operating Loss Regime for Tax Years Ending on and After July 31, 2019, N.J. Division of Taxation, revised Feb. 18, 2020; Technical Bulletin TB-95, Net Operating Losses and Combined Groups, N.J. Division of Taxation, Feb. 18, 2020.
35 N.J. Rev. Stat. § 54:10A-4(k)(4), (5).
36 N.J. Rev. Stat. § 54:10A-4(u)(2)(B).
37 N.J. Rev. Stat. § 54:10A-4.6.g(1).
38 Id.
39 N.J. Rev. Stat. § 54:10A-4.6.g(4).
40 Taxpayers were required to file Form DT-1, New Jersey Corporation Business Tax Statement of Net Deferred Tax Liability Deduction, by July 1, 2020 to claim this deduction. Technical Bulletin TB-96, Net Deferred Tax Liability Deduction and Combined Returns, New Jersey Division of Taxation, Feb. 24, 2020.
41 N.J. Rev. Stat. § 54:10A-4(k)(16).
42 N.J. Rev. Stat. § 54:10A-4(k)(16)(E)(ii).
43 N.J. Rev. Stat. § 54:10A-4(k)(16)(E)(iii).
44 N.J. Rev. Stat. § 54:10A-4(k)(16)(E)(i).
45 N.J. Rev. Stat. § 54:10A-4(k)(2)(I); A.B. 5323, § 14, repealing N.J. Rev. Stat. § 54:10A-4.4.
46 The Joyce and Finnigan methods refer to two California tax matters, Appeal of Joyce Inc., Dkt. No. 66-SBE-070 (Cal. State Bd. of Equal. Nov. 23, 1966) and Appeal of Finnigan, Dkt. No. 88-SBE-022 (Cal. State Bd. of Equal. Aug. 25, 1988). As explained in the fiscal note for A.B. 5323, the Joyce rule only requires the inclusion of New Jersey receipts from group members with CBT nexus in the numerator of the apportionment factor, while the Finnigan rule includes the New Jersey receipts of all group members in the numerator of the apportionment factor.
47 N.J. Rev. Stat. § 54:10A-4.7.e.
48 N.J. Rev. Stat. § 54:10A-4.7.a.
49 A.B. 5323, § 13. The income is sourced under N.J. Rev. Stat. §§ 54:10A-6–54:10A-10.
50 Id. The income is sourced under N.J. Rev. Stat. §§ 54A:1-1 et seq.
51 Fiscal Note for A.B. 5323, New Jersey Legislative Budget and Finance Office, June 9, 2023. For additional discussion of this legislation, see Technical Bulletin TB-107, Changes to Corporation Business Tax, Gross Income Tax, and Other Requirements from P.L. 2023, c.96, New Jersey Division of Taxation, July 11, 2023. TB-107 contains detailed information on the CBT treatment of non-U.S. corporations, technical changes to the water’s edge group provisions, and numerous procedural items.
52 N.J. Rev. Stat. § 54:10A-5.41.
53 Note that this sharply contrasts with the change to the tax treatment of GILTI recently enacted by Minnesota. For further information, see GT SALT Alert: Minnesota taxes GILTI and net investment income, increases sales tax.
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