New Jersey Piggy-Backs Federal S Corporation Elections
New Jersey Piggy-Backs Federal S Corporation Elections.
On December 22, 2022, Governor Murphy signed P.L.2022, c.133 (A4295/S2876) that eliminates the requirement to affirmatively make a New Jersey S corporation election; ends the New Jersey COVID-related extension for State tax assessments and refund interest and adapts New Jersey Partnership Audit Rules to the new federal partnership audit rules.
This article addresses the recent New Jersey changes piggy-backing New Jersey S corporation elections with a Federal S corporation elections. Our next articles will address the COVID related issues and the partnership audit rules.
Background. Since 1994, New Jersey has allowed a federal S corporation that has made a valid separate New Jersey election to be taxed as a “New Jersey S Corporation.” Generally, an election to be a New Jersey S Corporation, once effective, continues until the corporation’s federal S status ends.
The new law dramatically changes New Jersey’s treatment of S corporations. The Division of Taxation was expected to publish guidance regarding the new S corporation provisions in early February, however, insofar as it has not been released, guidance could be imminent.
Requirement for Separate New Jersey Election Eliminated. Under the new law, a separate election to be treated as a New Jersey S election will no longer be required. Instead, New Jersey will piggyback a federal S corporation election and treat a federal S corporation as a New Jersey S corporation unless all the corporation’s shareholders elect not to be taxed as a New Jersey S corporation, and file an opt out election. The new law is effective for tax years beginning on or after December 22, 2022.
Any S corporation doing business in New Jersey or having or exercising its franchise in New Jersey, or deriving receipts, engaging in contracts, or employing or owning capital or property in New Jersey, or registered to do business in New Jersey, which does not make an opt out election will be taxed as a New Jersey S corporation
The Opt Out Election. A federal S corporation may elect not to be taxed as a New Jersey S corporation by making an opt out election. An opt out election requires the consent of all the shareholders of the federal S corporation on the date on which the opt out election is made. An election to opt out may 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 S corporation’s tax return. An election to opt out is effective for the taxable year for which the election is made and for each succeeding taxable year until the opt out election revoked.
An opt out election may be revoked if shareholders holding more than 50 percent of the shares of stock of the S corporation on the date on which the revocation is made consent to the revocation. The revocation of an opt out election is effective on the first day of the taxable year if made on or before the fifteenth day of the third month of the taxable year. If the revocation is made after such date, the revocation is effective for the following taxable year, unless the shareholders rescind the revocation before December 31 of the current year. An election of 100% to opt out / 50% to opt back in or revocation made pursuant to this subsection shall be made in a form and manner prescribed by the Division.
Effective Date of New Law. The new law governing S corporations is effective immediately but applies for taxable years and privilege periods beginning after December 22, 2022.
Because the new law is effective for taxable years and privilege periods beginning after December 22, 2022, corporations organized after December 22, 2022, which make a federal S election will be subject to the new New Jersey S election piggybacking rules. Unless an opt out election is made for the corporation’s initial short taxable period, the corporation will be a New Jersey S corporation for that the short period return.
It is not clear how the new law will be applied to an existing federal S corporation which has not made separate New Jersey S election and therefore was a New Jersey C corporation under prior law. Guidance from the Division of Taxation may allow federal S/New Jersey C corporations to retain their New Jersey tax classification. Alternatively, the Division may require these corporations to file an opt out election confirming their classification as a New Jersey C corporation.
A federal S corporation can elect for its wholly owned subsidiary to be a federal Qualified Subchapter S Subsidiary (QSSS). Under prior law, if the parent corporation was an electing New Jersey S corporation, the Division of Taxation allowed a separate New Jersey QSSS election to be made for the subsidiary. If a separate New Jersey QSSS election was not made, the subsidiary was classified as a New Jersey C corporation. The new law does not address the New Jersey classification of a federal QSSS. Guidance will be required to clarify the application of the New Jersey piggyback rules to a federal QSSS. The Division could allow each a subsidiary to retain its current tax classification or, alternatively, require a separate opt out election.
Consenting/Nonconsenting Shareholders. Under prior law, a shareholder consented to the corporation’s election to be treated as a New Jersey S corporation and to New Jersey’s right and jurisdiction to tax and collect the tax on the nonresident shareholder’s S corporation income by signing the New Jersey S corporation or New Jersey QSSS Election Form CBT-2553. An S corporation was required to withhold Gross Income Tax from a shareholder’s pro rata share of S corporation income if (i) the shareholder was a nonresident of New Jersey; (ii) the shareholder became a shareholder in a New Jersey electing S corporation, after its initial election ; and (iii) the shareholder failed to consent to the corporation’s New Jersey S election.
The new law provides for piggybacking of a federal S election. A corporation wanting to be classified as a New Jersey S corporation will not make a separate election and its shareholders will not consent, as a part of the corporation’s election, to be treated as a New Jersey S corporation and to New Jersey’s right and jurisdiction to tax and collect the tax on the shareholder’s S corporation income. However, the new law retains the requirement that the S Corporation and each shareholder affirmatively consent to existing jurisdictional requirements, in a form and manner to be determined by the Division of Taxation. Guidance will be need regarding the manner of making shareholder consents and the obligation of the corporation to pay Gross Income Tax on a nonconsenting shareholder’s pro rata share of S corporation items allocated to New Jersey.
Required Reporting of S Corporation Shareholder Changes. The new law requires a corporation to report any change in its shareholders or their share of ownership to the Division of Taxation in the form and manner prescribed by the Division. Previously, the Division of Taxation required a New Jersey S corporation to report a change in shareholders using the Division of Revenue and Enterprise Services’ S-Corporation (S-Corp) Election Service or by filing Form CBT-2553.
Retroactive Election of S corporation Status.
In 2008, the Division of Taxation promulgated a procedure for providing uniform retroactive relief for corporations which inadvertently failed to make a timely valid New Jersey S Corporation election. The regulations cautioned that retroactive election relief would only be granted if specific criteria were satisfied.
The new law directs the Directors of the Divisions of Revenue and Enterprise Services and Taxation, when determining whether to grant retroactive election of S corporation status, to liberally construe regulatory requirements in favor of the corporation and grants to the administrators the discretion to authorize retroactive S corporation status in circumstances in which a taxpayer may not be capable of meeting all regulatory requirements for such retroactive election through no fault of the taxpayer.
Administrative Guidance Expected. The Directors of the Divisions of Taxation and Revenue and Enterprise Services are directed to take anticipatory administrative action in advance as is necessary to effectuate the purposes of the new law. The Division of Taxation planned to publish guidance regarding the new S corporation piggybacking provisions in early 2023 and when it is released, we will endeavor to summarize in another article.