The 2017 Federal Tax Cuts and Jobs Act was met with mixed fanfare. While some businesses and tax payers experienced a reduction in their tax liability, others experienced an increase. One major reason that some taxpayers were hit with a tax increase was centered on the new law’s reduction in state and local tax deductions (SALT). Since the new legislation placed a federal cap of $10,000 on SALT tax deductions, some taxpayers in states with higher taxes experienced a reduction in the deductions they could claim, resulting in higher taxes paid. In fact, according to data from the National Association of Realtors, prior to the Tax Cuts and Jobs Act, the four states with the highest average SALT deductions were New York ($21,779), Connecticut ($19,563), California ($18,770) and New Jersey ($18,092).
While it is clear that taxpayers in states with the highest tax rates are at a disadvantage, exactly how to solve the problem is something some states have struggled with. Many of the previous “workarounds”, which included creative approaches to using charitable funds, proved largely unsuccessful. However, the state of New Jersey recently implemented a new law to assist some businesses in circumventing the federal cap.
The “Pass-Through Business Alternative Income Tax Act” was established as a way for pass-through entities like partnerships, multi-member LLCs, and S corporations to pay taxes at an entity level, thus restoring the deductibility of state income tax. With the implementation of this legislation, New Jersey joins Connecticut, Louisiana, Oklahoma, Rhode Island and Wisconsin in enacting some form of entity-level tax on pass-through entities. A 30-page report released in August by the 25-member Economic and Fiscal Policy Working Group panel convened by Senate President Stephen Sweeney states that the changes could provide up to $450 million a year in federal tax cuts for small business owners, professionals, and their families.
According to Christine Darcy, CPA and Principal at Darcy and Company CPAs, LLC in Spring Lake, NJ, “Small businesses face many challenges doing business in New Jersey. The loss of the federal tax deduction for state income taxes on pass through income was putting NJ business owners at yet another disadvantage. This legislation is a step forward for small businesses and overall creates a better business environment in New Jersey.” 
What businesses are not included?
Unfortunately, not all businesses will be able to take advantage of the new plan. Darcy notes that sole proprietors and single member LLCs are not currently included in this plan. As a result, certain entities may want to consider reviewing the pros and cons of changing the structure of their company, including a subchapter S election. While this may be advantageous for some, there are important considerations to review before rushing to make the change. From additional state business and payroll taxes, such as disability and unemployment, to increased complexity and tax preparation fees, numbers should be run to identify if any net tax savings will be realized from the election. 
Will this plan stick?
It is also important to be aware that all tax plans (especially tax “workarounds”) are subject to change or possible disallowance by the IRS. However, some are confident in the viability of the plan.
According to State Sen. Paul Sarlo (D., Bergen), chairman of the Senate Budget and Appropriations Committee and the prime sponsor of the legislation, “We’re going ‘Back to the Future’ with an IRS-proof solution. It will return to a tax system that was in place for decades. This legislation doesn’t solve the whole problem created by a federal tax law that targets New Jersey by sharply curtailing the federal deduction for state and local taxes. But we are going to do everything we can to help New Jersey taxpayers."
What should businesses do next?
As with all tax considerations, it is critical to speak to your accountant to determine the potential impact of these changes before making any decisions. Additionally, taxpayers in other states outside of New Jersey should keep an eye on any potential changes in their home state. Since everyone’s situation is unique, consider speaking to your tax advisor to determine the most appropriate approach for your individual circumstances.
Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.
