What Businesses Qualify for the NJ BAIT Deduction?
The New Jersey Business Alternative Income Tax, also known as BAIT or NJ BAIT, took effect on January 1, 2020, but was revised on January 18, 2022. This new state law aims to help small business owners realize even greater savings on their federal income tax returns.
While the federal tax benefit can be substantial, you may feel overwhelmed by the complexity of the law’s filing and tax payment requirements. And, as with other tax laws, you need to carefully understand how the NJ BAIT can reduce your tax liability and impact your business in case it qualifies.
So if you’re a business owner preparing for taxes, consider this article as your go-to resource in fully understanding the numerous benefits of NJ BAIT, provided that you meet the requirements.
What is NJ BAIT?
Signed into law in January 2020, NJ BAIT allows pass-through entities (PTEs), such as partnerships, limited liability companies (LLCs), and S corporations, to pay their income taxes at the entity level instead of the personal level. This new tax law is a viable solution to help business owners mitigate the negative impact of the State and Local Tax (SALT) deduction cap. The NJ BAIT is estimated to save New Jersey business owners $200 to $400 million annually.
Taxpayers can claim a refundable gross income tax credit with income from pass-through businesses. Under the federal Tax Cuts and Jobs Act (TCJA), there is no limit on deducting state taxes paid at the entity level, as limits only apply at the individual level. Right now, owners of pass-through businesses can only deduct up to $10,000 in state and local taxes from their personal income taxes.
Qualifying Businesses for NJ BAIT
The New Jersey BAIT is one of many Pass-Through Entity Tax (PTET) laws in place across the country as a partial solution to the SALT deduction cap. On this note, the first and most important requirement to qualify is that a business must be a pass-through entity.
Important notes on NJ BAIT qualifications:
- A pass-through entity refers to a partnership, S corporation, or limited liability company.
- This tax is not for sole proprietors, LLCs with only one member, or corporations that don’t choose to be taxed as New Jersey S-Corporations.
- It must have at least one member subject to tax on distributive proceeds under the New Jersey Gross Income Tax Act.
Also read: Small Business Taxes for Beginners
How is Tax Liability Calculated?
To determine the tax payable, the pass-through entity must add up each member’s share of distributable proceeds (income sourced to New Jersey) for the taxable year.
The sum of these distributive proceeds determines the tax rates, which are as follows:
- For the first $250,000 of income, the tax rate is 5.675 percent.
- The tax rate for over $250,000 but not over $1 million is 6.52 percent.
- Amounts greater than $1 million but less than $5 million are subject to a 9.12 percent tax rate.
- A tax rate of 10.9 percent applies to amounts higher than $5 million.
Tax must be calculated on the distributive proceeds received by each member, including tax-exempt members. The exemptions include corporations exempt from the Corp Business Tax Act under NJSA 54:10A-3, 501(c)(3) tax-exempt organizations, and IRS-approved retirement plans.
How Does NJ BAIT Work?
When a pass-through business elects to participate in BAIT and pays the tax, its federal income is reduced. This has the same (or better) effect as deducting state or local taxes on an owner’s individual federal income tax return. The individual owner then gets credit for its share of the payment on its New Jersey tax return.
This election affects all owners, and each owner’s tax situation may differ. Some complicating factors include:
- One owner may have a large balance owed while another does not;
- One owner may have another business; and
- One owner may be a non-profit entity.
So when considering participation in BAIT, these and other factors must be carefully taken into account.
Updates to NJ BAIT Law
Below are some notable changes to the NJ BAIT law effective starting January 1, 2022:
- Tax Base: The new law will expand the PTE tax base to include all income allocated to New Jersey resident partners, regardless of source, while retaining only income allocated to non-resident partners. However, this change only affects partnerships and multi-members, and shareholders of S corporations will continue to be restricted to income allocated to New Jersey.
- Non-resident Withholding: Non-resident partners will no longer be required to pay withholding in NJ Partnerships if they can reasonably expect to be refunded due to the NJ BAIT Credit.
- Tiered Partnerships and PTE Credits: For Tiered Partnerships, the PTE credit can now be allocated to those who own the upper-tier partnership, and partnerships with S Corporations are subject to the same rules.
- PTE Tax Overpayments: Overpayments of the BAIT can now be credited to the following tax year. This will reduce the unnecessary burden and risk of penalty where a taxpayer may be waiting for a refund required to pay an estimate on time.