This article originally appeared on NJ Spotlight.
Legislation seeking to restore a major tax benefit for thousands of New Jersey small-business owners hit hard by the recent capping of a federal write-off for state and local taxes is now a step closer to becoming law.
Lawmakers in both houses voted overwhelmingly on Monday in favor of a bill that would reclassify taxes the state currently collects from what are known as “pass-through” entities, including partnerships, limited-liability corporations and so-called S corporations.
The proposed change is not projected to have any impact on the state’s bottom line. But it would create what’s known as a “workaround” for small businesses and other pass-throughs so they could again fully deduct their state taxes on federal returns.
Targeting Trump tax code
The bill was drafted in response to a major overhaul of the federal tax code that was signed into law by President Donald Trump in 2017. That tax law capped the federal income tax write-off for state and local taxes known as SALT at $10,000, but it preserved an unlimited deduction for state and local business taxes.
Sponsors have estimated the bill could save small-business owners as much as $450 million annually. The legislation was passed in the Assembly in a 77-0 vote, and the margin in the Senate was 34-0. It now goes to Gov. Phil Murphy for final consideration.
“The tax law enacted by the Republican Congress was aimed to punish blue states like New Jersey, and we need to do everything we can to offset its negative effects,” said Sen. Troy Singleton (D-Burlington).
“Protecting New Jersey businesses against sweeping federal changes ensures New Jersey’s economy stays on the right track and business owners continue to thrive,” said Assemblyman Dan Benson (D-Mercer).
Dubbed the Tax Cuts and Jobs Act, the 2017 overhaul of the federal tax code was meant to stimulate the economy by reducing individual income-tax rates and slashing the burden on corporations and people behind large estates. Changes were also made to several exemptions and deductions, including the standard deduction. To help pay for the tax changes, the $10,000 limit on the SALT write-off was put in place.
The impact of the new tax rules varied widely among New Jersey residents, but many were hit hard since the combination of local property-tax bills, which average nearly $9,000, and high state income taxes could no longer be fully deducted from their federal taxes — increasing the amount of income subject to the new federal tax rates.
GOP moves to block NJ plans
Murphy and Democratic lawmakers responded almost immediately by proposing a workaround for homeowners that sought to reclassify their property tax payments as charitable contributions, since such contributions have remained fully deductible following the 2017 tax overhaul. But that workaround has been held up by regulations enacted by the Trump administration, prompting an ongoing challenge from the state.
The 2017 tax overhaul also prompted the proposed SALT workaround for small businesses and the owners of pass-through entities. To remedy the loss of a full SALT deduction for those taxpayers, the legislation calls for them to be taxed by the state at what’s known as the entity level instead of taxing the profits of each individual through the state income tax.
The proposed reclassification would apply to an estimated 115,000 small businesses that register as S corporations, and another estimated 175,000 limited liability corporations. It would effectively recreate the way the state handled the taxing of such entities in the early 1990s, before policymakers decided to switch to the current format.
Under the legislation, a tax rate of 5.675% would be levied on pass-through income totaling up to $250,000 in a given tax year; 6.52% on income totaling more than $250,000 but less than $1 million; 9.12% on income totaling more than $1 million but less than $5 million; and 10.9% on any income above $5 million.
Businesses would not be forced to use the new tax rule if it eventually is signed into law by Murphy, but those that do would receive a tax credit against their gross income-tax liability to ensure they are not double-taxed.
A fiscal-impact analysis prepared by the nonpartisan Office of Legislative Services indicated the legislation would be “revenue neutral” for the state because the design of the tax change is not expected to impact the total amount of taxes that New Jersey will collect from the pass-through entities. Officials from the state Department of Treasury did not respond to a request for comment on Monday.
Tax experts have suggested the small-business workaround is on much safer ground than the one that Murphy and lawmakers attempted to create last year for homeowners. It was also supported by the New Jersey Society of Certified Public Accountants and other business groups during legislative hearings.
Sponsors also noted a similar SALT-cap workaround for small businesses has already been enacted in Connecticut, another state hit hard by the establishment of the $10,000 cap.
“It would be hard for the IRS to challenge our state’s prerogative to return to a tax system that was in place for 17 years,” said Sen. Paul Sarlo (D-Bergen).
“This is a clear win for the New Jersey’s businesses, and for our economic future,” said Assemblyman Roy Freiman (D-Somerset).
Meanwhile, Monday’s votes in Trenton came as Murphy appeared at a news conference in Saddle Brook, alongside U.S. Rep. Bill Pascrell (D-9) to promote federal legislation that Pascrell is sponsoring that is seeking to fully repeal the $10,000 cap for all federal taxpayers. That measure would establish a $20,000 SALT-deduction cap for married couples who file jointly for tax year 2019, and then abolish the cap altogether for tax years 2020 and 2021. It would also restore a 39.6% top-end federal income-tax rate to help cover the cost of repealing the SALT cap.
But Pascrell’s bill is unlikely to pass the Republican-controlled U.S. Senate, increasing the importance of the action taken on Monday by state lawmakers.