In late December, the New Jersey Legislature passed Assembly Bill 4295, which made some interesting changes to New Jersey tax laws. These changes could have a significant impact on New Jersey resident and nonresident taxpayers who have investments in businesses. Specifically, the legislation ended COVID-19-related tax extensions of the statute of limitations, eliminated the requirement that corporations affirmatively and separately elect New Jersey S corporation status, and conformed New Jersey rules on partnership audits to the federal adjustments and the multistate tax commission’s model law.
New Jersey’s statute of limitations runs for four years, or three years for personal income taxes, in each case from the filing of the tax return. In 2020, after COVID-19 hit the state, the statute of limitations was suspended and therefore the time period to assess taxes was in essence open-ended.
The new tax bill terminates this extension and therefore provides certainty to taxpayers with respect to prior tax years that should be closed from an audit and assessment standpoint.
The elimination of the separate S corporation election filing puts to an end a trap for the unwary taxpayer. New Jersey had previously required corporations that elect to be taxed as a subchapter S corporation for federal income tax purposes to file a separate election for New Jersey tax purposes. Most states just piggyback on the federal election; New Jersey, by requiring a separate election, had historically been a trap for unwary taxpayers that put in jeopardy subchapter S treatment for New Jersey income tax purposes.
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tax-planning Spotlight
The tax law change makes the election automatic at the state level, meaning that any entity that files a subchapter S election for federal tax purposes will also be treated as an S corporation for New Jersey corporate tax purposes. Entities can opt out of S corporation treatment for New Jersey corporate tax purposes, however. The opt out requires the consent of 100% of the corporation’s shareholders and can be made at any time preceding the tax year for which the opt out is to be effective, through the due date (with extensions) for the corporation’s return.
Two planning thoughts: First, from a transactional perspective, going forward in a stock sale transaction, sellers should get a covenant that the buyer will not elect out of S status for the year of the transaction, as sellers should not have their New Jersey S status put at risk. Second, given the unanimity requirement to elect out of subchapter S status, to minimize the hold out value of minority shareholders drafters might consider including in shareholders agreements a provision mandating the consent to the revocation if a majority of the shareholders approve.
The election to opt out can be revoked with the consent of 50% of the corporation’s shareholders. That revoked election is effective for the current tax year if made by the 15th day of the third month (as is the case with the federal S election) or for the following year if made after that date.
Interestingly, while the separate New Jersey election need not be filed, the corporation and each shareholder do have to consent to certain jurisdictional requirements, including New Jersey’s right to tax the income from the corporation. It is not yet clear what that consent filing will look like. In addition, the new law appears to only apply to tax years beginning after the date of enactment. So existing S corporations must make sure their New Jersey S elections were properly made.
With respect to partnership audits, effective Jan. 1, 2018, partnerships became subject to a new audit regime at the federal level. The new rules provide the Internal Revenue Service with the ability to audit, assess and collect tax underpayments from a partnership at the entity level; in contrast, while audits were conducted at the partnership level previously collection and assessment occurred at the partner level.
Bloom
The Multistate Tax Commission has promulgated a model statute for states to adopt the new federal partnership audit regime. In the recent bill, New Jersey adopted the model statute for handling partnership audits. Partnerships are now required to report any federal partnership audit adjustments to the Division of Taxation. Partners are required to pay any resulting New Jersey gross income tax liability unless the partnership makes a payment on their behalf. The failure of the partnership to report and/or pay the tax does not stop the director’s ability to collect any deficiency from the partners.
Bryan Bloom is a tax partner at Faegre Drinker, where he is based in the firm’s Florham Park office.
