New Jersey Finally Follows Federal S Elections and Adapts to Federal Centralized Partnership Audit Structure

On December 22, 2022, Governor Murphy signed A.B. 4295 into law. The law primarily conforms New Jersey’s laws regarding the making of S elections to federal law and also adapts the New Jersey Gross Income Tax laws to the federal centralized partnership audit rules adopted several years ago.

New Rules Regarding New Jersey S Elections

For many years, a corporation could elect to be treated as an S corporation for New Jersey tax purposes only if it affirmatively made a separate New Jersey election, in addition to the federal S election under IRC Sec. 1362. Under new laws effective for taxable years beginning after December 22, 2022, by default, New Jersey treats any corporation that has made a valid S corporation election for federal tax purposes as an S corporation for New Jersey tax purposes. This structure is in line with the vast majority of states that automatically afford S corporation status to a business entity that is a valid S corporation for federal income tax purposes.

Under the new act, a corporation may separately elect not to be treated as an S corporation under New Jersey law. This can be helpful if a corporation has a number of New Jersey nonresident shareholders who do not wish to file individual New Jersey Gross Income Tax returns in New Jersey and would have no other tax nexus with New Jersey. To make such an opt-out election, 100 percent of the shareholders must consent. The election can be made for any taxable year at any time during the preceding taxable year or at any time on or before the due date or extended due date of the corporation’s tax return.

Tie-In to Federal Partnership Tax Audit Rules

The second change made by the act is that it adapts the New Jersey Gross Income Tax laws and a number of procedural provisions of New Jersey tax law to the federal centralized partnership audit regime enacted as part of the federal 2015 Bipartisan Budget Act. As a result of these changes and clarifications:

• Partnerships required to file New Jersey information tax returns must report any federal partnership audit adjustments made by the IRS by filing a copy of the federal adjustments report with the NJ Division of Taxation within 90 days after the federal final determination date.
• A partnership audited at the federal level with audit adjustments can elect to pay the New Jersey taxes triggered by such adjustments in lieu of taxes otherwise owed by its direct and indirect partners, along with interest and penalties, within 180 days after the final determination date. Otherwise, the partners of the reviewed year must make payment of New Jersey Gross Income Tax, interest, and penalties triggered by the federal adjustments.
• The Division possesses the legal authority to assess the New Jersey tax resulting from any federal adjustments against the partnership or its partners.
• The state partnership representative shall have the sole authority to act on behalf of the partnership, and the partnership’s direct and indirect partners shall be bound by any actions taken by the partnership with respect to the reviewed year. The partnership’s federal partnership representative is by default the state partnership representative unless the partnership designates some other person in writing.

These New Jersey partnership audit and adjustment provisions take effect immediately and apply to any adjustments to federal table income on or after January 1, 2020.

Conclusions

The marrying of New Jersey S corporation elections with federal elections removes a New Jersey trap for the unwary that has created problems for decades. The ability to opt out and be treated as a C corporation adds some flexibility, especially useful for corporations with a number of New Jersey nonresident shareholders.

The amendments tying New Jersey’s partnership tax law to the federal centralized partnership audit rules clarify and conform New Jersey’s law to the federal law. The specification of who is the state partnership representative should reduce potential disputes and implicitly makes it easier to draft the relevant tax audit provisions of partnership agreements and LLC operating agreements.