On June 25, 2018, the New Jersey Legislature passed Assembly Bill 4262 (the Bill) to make several changes to the New Jersey corporation business tax (CBT). Governor Phil Murphy has indicated that he may veto the entire Bill or make line-item vetoes because the Bill is a dramatic departure from his proposed tax plan. The Governor’s plan sought several major tax changes, including: a “millionaires tax,” an increased state sales tax rate, combined reporting with a limited “water’s-edge” election, market-based sourcing for receipts from the sale of services, and taxation of international holding companies. None of these provisions made it into the current version of the Bill.

If the Governor vetoes all or part of the Bill, the New Jersey Legislature can override the veto with a two-thirds majority vote in both houses (27 votes in the Senate and 54 votes in the General Assembly). The Governor and Legislature will have to act quickly because the current session of the Legislature ends June 30, 2018, and New Jersey is facing a potential government shutdown for the second year in a row. Key provisions of the Bill are discussed below.

Temporary CBT Surtax

Beginning with tax periods ending on or after January 1, 2018, the Bill imposes a two-year CBT surtax at two different rates, depending on a corporation’s “allocated net income.” For corporations with allocated net income between $1 million and $25 million, the surtax rate is 2.5%, for a total CBT rate of 11.5%. The surtax increases to 4% for corporations with allocated net income over $25 million, for a total CBT rate of 13%. Credits cannot be applied against the surtax except for credits for installment payments, estimated payments and overpayments from prior years. The surtax does not apply to public utilities.

CBT surtaxes are not new in New Jersey. Previously, New Jersey imposed a 4% surtax for tax periods beginning on or after July 1, 2006, and before July 1, 2009.

Dividend Exclusion Reduction

The Bill reduces the dividend exclusion for taxpayers receiving dividends from an 80% or greater owned subsidiary. For the tax period beginning after December 31, 2016, the dividend exclusion is reduced from 100% to 90%. For the tax periods beginning on or after January 1, 2018, the dividend exclusion is 95%.

Provisions Relating to the Tax Cut and Jobs Act (TCJA)

Global Intangible Low-Taxed Income (GILTI)

The TCJA created new IRC § 951A, which taxes a US shareholder on its income from controlled foreign corporations (CFCs), to the extent this income is in excess of a fixed return on the tangible assets of such CFCs. Although the income is subject to tax at regular rates, under new IRC § 250, a deduction is allowed for 50% of the amount included in income, effectively taxing GILTI at a 10.5% tax rate for federal purposes. Further, foreign tax credits are available to offset GILTI at the federal level at a rate of 80%. As a result, for federal purposes no GILTI tax will be due where the CFC income is taxed in the foreign jurisdiction at a rate of at least 13.125%.

Since “federal taxable income before the net operating loss deduction and special deductions” is the starting point for computing New Jersey entire net income, and the Bill fails to decouple from the TCJA with respect to new IRC § 951A, GILTI is included in the computation of New Jersey entire net income. In addition, the 50% GILTI deduction under IRC § 250 is likely not available since it is a federal special deduction.

Foreign-Derived Intangible Income (FDII)

The TCJA also includes a new special deduction for certain foreign-derived income earned by a United States corporation. Under IRC § 250, the deduction is for 37.5% of the United States corporation’s FDII. FDII is broadly defined as income from the sales, which includes licenses, of property to foreign persons, and income from services performed for foreign persons. FDII must exceed a fixed return on the tangible assets of the US corporation to be eligible for the federal deduction.

The Bill does not address FDII and since the FDII deduction is a federal special deduction it is likely not available.

Interest Deduction Limitation

The TCJA expands the interest deduction limitation under IRC § 163(j). The TCJA limits the deductibility of interest paid or accrued to net interest income plus 30% of adjustable taxable income. Any disallowed interest may be carried forward indefinitely.

For tax periods beginning after December 31, 2017, the Bill specifies that the interest deduction limitation under IRC § 163(j) will apply on a pro-rata basis to interest paid to both related and unrelated parties. However, any interest that is subject to add-back will be excluded from the pro- rata computation.

Qualified Business Income Deduction

Under new IRC § 199A, taxpayers other than C corporations may deduct 20% of qualified business income earned in a qualified trade or business, subject to certain adjustments and limitations. The deduction is a multistep calculation, but in general is limited to 20% of the taxpayer’s qualified business income.

The Bill explicitly decouples from the new IRC § 199A qualified business income deduction.

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