Tuesday, January 12, 2021
“BAIT” AND SWITCH
I am trying to understand the legitimacy of the new “NJ BAIT”.
As explained on the “Business Alternative Income Tax” (BAIT) FAQ page of the NJ Division of Taxation website –
“For New Jersey tax purposes, income and losses of a pass-through entity are passed through to its members. However, for taxable years beginning on or after January 1, 2020, pass-through entities may elect to pay a Pass-Through Business Alternative Income Tax due on the sum of each of the member’s share of distributive proceeds. The member(s) may then claim a tax credit for the amount of tax paid by the pass-through entity on their share of distributive proceeds.”
The website of an accounting firm I found in a search tells us –
“The significance of this election is that the business taxes paid by an eligible entity can be deducted in determining federal income that passes-through to the owners, resulting in less federal tax paid by the owners on their share of the PTE income.”
I assume the entity’s BAIT payment is claimed as a state income tax deduction on the federal Form 1065 or 1120-S, reducing the net taxable income passed-through to the partner or shareholder.
But what is actually happening? The pass-through entity is making a payment of state income tax, calculated on the income of the entity, on behalf of the partner or shareholder. The income of the entity, before any deduction for the BAIT, is still passed-through to the individual partners or shareholders on the NJK-1 and reported on Line 21 or 22 of the NJ-1040. The partners’ or shareholders’ individual NJGIT liability is calculated based on this income.
The BAIT payment allocated to the partner or shareholder is in effect an estimated tax payment of NJGIT. If the actual tax cost of the pass-through income is more than the BAIT payment the partner or shareholder pays the additional tax. If the tax cost is less than the allocated BAIT payment the partner or shareholder gets a refund or reduces the balance due.
The BAIT payment made by the entity is not an expense of the entity but a payment made on behalf of the partner or shareholder. It is not an expense of the entity, but a distribution of partner capital or shareholder PTI made to the State of New Jersey.
It appears to me that this is just a scam to allow New Jersey taxpayers to legally cheat on their federal income tax return. The GOP Tax Act limited the itemized deduction for State and Local Taxes (SALT) to $10,000. The BAIT is a way to “work around” this limitation so taxpayers could deduct a portion of their NJ state income tax, calculated on their NJ state individual income tax return, somewhere else on the federal return.
I certainly understand what New Jersey is trying to do. I personally oppose the SALT limit – but for a unique reason (see my post “Defending the Deductions for Taxes and Mortgage Interest”). But what about “substance over form”? You can call it a “credit” and not an estimated tax payment, but if it walks like a duck . . .
To be an actual legitimate entity-level state income tax should not the election be to pay BAIT on the entity’s net taxable income in lieu of passing the entity’s income to its partners or shareholders? The entity would elect to not pass through its income to partners or shareholders. An entity electing BAIT would not issue a NJK-1 to its partners or shareholders, and the partners or shareholders would not report any income from the entity on Form NJ-1040 Lines 21 or 22. Since the individual partner or shareholder is not paying NJGIT on the income of the entity there would be no BAIT credit on the NJ-1040.
So, what do you think?