New Jersey addresses S corporation elections

On Dec. 22, 2022, New Jersey enacted legislation that addresses S corporation elections, partnership audit procedures, and COVID-related extensions.¹ Specifically, taxpayers that qualify as S corporations for federal tax purposes are automatically S corporations for New Jersey tax purposes. The state also adopts provisions consistent with the federal partnership audit regime. Finally, the legislation ends the COVID-19 extensions that were enacted in 2020.


 

Automatic S corporation election 

For taxable years and privilege periods beginning after Dec. 22, 2022, the legislation eliminates the requirement that a taxpayer that qualifies as an S corporation for federal tax purposes make a state-specific election to obtain New Jersey S corporation status.² As a result, a taxpayer that has made a valid federal election to be an S corporation is automatically a New Jersey S corporation for the taxable year.

An S corporation may elect not be taxed as a New Jersey S corporation if 100% of the shareholders consent on the date on which the election is made.³ The S corporation opt-out election may be made for any taxable year at any time during the preceding taxable year or by the due date or extended due date of the S corporation’s tax return. The election to opt out is effective for the taxable year for which the election is made and for future years until it is revoked. The opt-out election may be revoked if shareholders holding more than 50% of the S corporation’s shares of stock consent to the revocation.⁴ If the revocation is made by the 15th day of the third month of the taxable year, it is effective on the first day of the taxable year. If the revocation is made after the 15th day of the third month of the taxable year, the revocation is effective for the following taxable year, unless the shareholders subsequently revoke the revocation before Dec. 31 of the current year. 

The Directors of the Divisions of Taxation and Revenue and Enterprise Services, when determining whether to grant retroactive election of S corporation status, are directed to liberally construe regulatory requirements in favor of the corporation.⁵ Also, the Directors have the discretion to authorize retroactive S corporation status in circumstances in which a taxpayer may be unable to meet all regulatory requirements for the retroactive election through no fault of the taxpayer.

Adoption of federal partnership audit procedures 

The Bipartisan Budget Act of 2015 enacted new federal partnership audit and assessment procedures for tax years beginning after Dec. 31, 2017.⁶ In January 2019, the Multistate Tax Commission (MTC) approved a model statute for reporting adjustments to federal taxable income and federal partnership audit adjustments.⁷ As explained in the MTC Hearing Officer Report, the new federal procedures shift the burden for assessing tax after a partnership-level adjustment from the Internal Revenue Service (IRS) to the partnership. For any adjustments to a taxpayer’s federal taxable income that occur on or after Jan. 1, 2020, New Jersey generally adopts the MTC’s model provisions for reporting adjustments to federal taxable income and federal partnership audit adjustments.⁸

Under the legislation, existing statutes are amended to require partnerships to report the final federal adjustments from a partnership audit or administrative adjustment request by filing the Federal Adjustments Report with the state within 90 days after the final determination date of the federal adjustments.⁹ New Jersey may assess tax against the partnership, and/or the direct or indirect partners, within two years of the Federal Adjustments Report filing with the state that results in additional New Jersey income tax for one or more direct or indirect partners.¹⁰ If a partnership files a Federal Adjustments Report that does not result in a federal imputed underpayment, and which is not taken into account by the partnership in the federal adjustment year partnership return, the partners may claim a credit or refund of the related state tax by filing an amended return or other schedule as required by the Director.¹¹

The legislation adds provisions that detail the requirements for reporting federal adjustments in the case of a partnership-level audit and administrative adjustment request.¹² The new provisions include steps that partnerships must follow in addition to filing the Federal Adjustments Report as discussed above.¹³ Also, the new provisions add filing and payment requirements for direct partners. No later than 180 days after the final determination date, direct partners must each: (i) file a Federal Adjustments Report indicating their distributive share of adjustment reported to them; and (ii) pay any additional amount of tax due as if final federal adjustments had been properly reported, plus any penalty and interest due.¹⁴

As an alternative to the procedures discussed above, partnerships may elect to pay the tax.¹⁵ An audited partnership making this election must: (i) no later than 90 days after the final determination date, file a completed Federal Adjustments Report and notify the state that it is making the election; and (ii) no later than 180 days after the final determination date, pay an amount in lieu of taxes owed by its direct and indirect partners that must be computed in accordance with specific statutory provisions.

The legislation includes new sections addressing: (i) assessments of additional New Jersey tax, interest, and penalties arising from adjustments to federal taxable income;¹⁶ (ii) estimated New Jersey tax payments during the course of a federal audit;¹⁷ (iii) claims for refund or credits of tax arising from final federal adjustments made by the IRS;¹⁸ and (iv) the scope of adjustments and extensions of time.¹⁹

Termination of COVID-19 extensions 

The legislation ends the extensions provided due to the COVID-19 pandemic. Under legislation enacted in April 2020, the provisions involving payment of interest upon any overpayment of tax were extended for six months after the conclusion of the state emergency declared by the governor under Executive Order 103 of 2020, or any extension of the order, or within six months after the return is filed, whichever is later.²⁰ Also, the statute of limitations to assess tax was extended for 90 days after the conclusion of the state of emergency or any extension.²¹ As amended by the recent legislation, the extension for the payment of interest on overpayment and the extension of the statute of limitations concluded on Dec. 22, 2022.²² Also, a new section provides that any assessment of tax that was allowed as a result of the extension of the statute of limitations but that is assessed after Dec. 22, 2022 is void.²³ The Director of the Division of Taxation must return any amounts collected from a taxpayer as a result of such assessment.²⁴

Commentary

This legislation makes significant changes that simplify the requirements for being treated as an S corporation in New Jersey as well as generally adopt the MTC’s uniform provisions concerning adjustments resulting from federal partnership audits. Also, the inconsistent provisions concerning extensions due to the pandemic are eliminated and the permanent statute of limitations provisions are reinstated.

The elimination of the New Jersey S corporation election requirement is consistent with almost all other states and is intended to reduce the administrative burden both for taxpayers and the Division.²⁵ The New Jersey S corporation and retroactive election processes have been cumbersome in the past. This change is expected to be revenue-neutral because it allows federal S corporations to opt out of being treated as an S corporation for New Jersey tax purposes.²⁶ Because there are many practical questions regarding the implementation of this change that need to be addressed by the Division, we anticipate that guidance will be released soon. Note that the Division of Taxation and the Division of Revenue and Enterprise Services must work in conjunction with each other to implement the changes since both divisions are involved in this matter. Taxpayers that may be most likely to have questions are hybrid entities that are federal S corporations and New Jersey C corporations as well as taxpayers that are seeking retroactive New Jersey S corporation election status. Also, newly incorporated entities may seek guidance on initial year consent procedures and entities considering a Pass-Through Business Alternative Income Tax (PTE/BAIT) election may need clarification.

The new partnership audit provisions contain statutory language that is very similar to the MTC’s model language. In effect, New Jersey has revised its rules to allow the state to flow through partnership audit adjustments that occur at the federal level. Many of the new provisions are supported by tax practitioners. The Council on State Taxation (COST) has issued a policy position that addresses the state reporting requirements for federal tax changes.²⁷ Some of COST’s recommendations are consistent with the MTC’s model language that has been adopted by New Jersey. Also, the American Institute of Certified Public Accountants (AICPA) recommends that states consider adopting the MTC’s model statute.²⁸ There is a possibility that the MTC may issue model regulations to implement its model statute or New Jersey may promulgate its own regulations to address its new procedures. Either way, the practitioner community will have an opportunity to provide input prior to adoption.²⁹

The termination of the COVID-19 extension provisions should simplify tax administration and compliance by adopting the administrative rules that were in effect prior to the pandemic. When New Jersey implemented the COVID extensions, the extension periods varied by item. In some situations, taxpayers were unable to file amended returns for refunds past a certain period but the Division was able to hold open those periods on audit. The recent legislation should eliminate any inequities caused by the inconsistent COVID extension periods. As a legislative change to the New Jersey statute of limitations, taxpayers should review the potential impact to their reserves for state tax provision purposes.

1 Ch. 133 (A.B. 4295), Laws 2022, enacted Dec. 22, 2022. 
2 N.J. Rev. Stat. §§ 54:10A-4(o), (p); 54:10A-5.22.3.a, c; 54A:5-10.12.
3 N.J. Rev. Stat. § 54:10A-5.22.d.
4 Id.
5 A.B. 4295, § 24.
6 P.L. 114-74, amended by P.L. 114-113 and P.L. 115-141. The federal partnership audit provisions begin at IRC § 6221.
7 Model Uniform Statute for Reporting Adjustments to Federal Taxable Income and Federal Partnership Audit Adjustments, Multistate Tax Commission, adopted Jan. 24, 2019.
8 As contained in A.B. 4295, §§ 6–12. 
9 N.J. Rev. Stat. § 54A:8-7.b. 
10 N.J. Rev. Stat. § 54A:9-4(c)(6). 
11 N.J. Rev. Stat. § 54A:9-8(j).
12 A.B. 4295, § 8.
13 A.B. 4295, § 8.c(1). In general, no later than 90 days after the final determination date, the partnership must: (i) file a completed Federal Adjustments Report; (ii) notify each of its direct partners of their distributive share; (iii) file an amended New Jersey Form 1065; and (iv) file an amended composite return for direct partners and pay the additional amount that would have been due had the final federal adjustments been reported properly as required. 
14 A.B. 4295, § 8.c(2).
15 A.B. 4295, § 8.d.
16 A.B. 4295, § 9.
17 A.B. 4295, § 10
18 A.B. 4295, § 11.
19 A.B. 4295, § 12.
20 Ch. 19 (S.B. 2338), § 1.b, Laws 2020. 
21 Ch. 19 (S.B. 2338), § 2, Laws 2020. 
22 A.B. 4295, § 16, amending S.B. 2338, § 1.b, Laws 2020; § 17, amending S.B. 2338, § 2, Laws 2020. 
23 A.B. 4295, § 18.
24 Id.
25 Note that New York may adopt a similar approach. New York Governor Kathy Hochul recently released an executive budget that would require all federal S corporations to be treated as S corporations for state tax purposes unless the corporation is a qualified New York manufacturer and chooses New York C corporation status. Under current New York law, federal S corporations with investment income above 50% of federal gross income are treated as New York S corporations. FY 2024 Executive Budget Briefing Book, New York State Division of the Budget, Feb. 1, 2023. 
26 Legislative Fiscal Estimate for A.B. 4295, New Jersey Office of Legislative Services, Nov. 22, 2022.
27 State Reporting Requirements for Federal Tax Changes, Policy Position, Council on State Taxation, Oct. 2019.
28 Talking Points on States Adopting the MTC Model Statute on Reporting Federal Adjustments, Including Partnership Audits, American Institute of Certified Public Accountants, Feb. 2, 2023. The AICPA notes that as of Jan. 17, 2023, 19 states have enacted legislation that conforms to the MTC model statute. Four other states (Arizona, Hawaii, Maine, and Rhode Island) have enacted partnership audit legislation that may need to be amended to follow the MTC model statute. 
29 The MTC has a public process for adopting model regulations and the New Jersey Division of Taxation offers a period for public comment when promulgating regulations. 

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