By WithumSmith+Brown Construction Services Team
Chaim Kofinas CPA/PFS/MST
For many years construction contractors based in New Jersey operated at a competitive disadvantage relative to out-of-state contractors who traveled to New Jersey to work on New Jersey construction projects. There are many causes that contributed to this state of affairs and very high on the list was New Jersey's archaic tax rules. With the stroke of a pen, Governor Jon Corzine changed the way all businesses are taxed and in particular construction contractors. Governor Chris Christie recently signed additional legislation that changes the competitive business landscape for the better.
Since the enactment of the corporate income tax, New Jersey-based businesses were required to report all their income as sourced and taxable to the state of New Jersey. The only exception to this rule was for businesses that had "a regular place of business" in a state other than New Jersey. A New Jersey-based business would meet the test of "a regular place of business" if the business rented or owned a fixed location outside of New Jersey and had a full-time employee working out of that location. Once a business met this test, it was allowed to apportion income to be taxed to New Jersey using the three factor formula. This rule presented a huge hardship for New Jersey contractors, especially subcontractors, whose only base of operations was in New Jersey and either occasionally or regularly performed contracts in other states. By operating in other states, they were required to pay tax to that state for the portion of business conducted in that state while at the same time reporting and paying tax to the State of New Jersey on all of their income. A credit mechanism was put into place to prevent double taxation; however, the credit never provided a full credit for all the taxes paid to other states.
New Jersey contractors (and other businesses as well) had another handicap that they needed to surmount. This roadblock, known as the "throwout rule," was enacted as part of the Business Tax Reform Act of 2002 signed into law by then Governor McGreevey. This rule applies to companies who are multijurisdictional and apportion their income. The throwout rule, simply put, requires sales made to states in which the business does not file a return be removed (or thrown out) from the denominator. By decreasing the denominator of the fraction the effect is increasing the apportionment percentage of income apportioned to the State of New Jersey and consequently the tax the New Jersey business pays. This increases the total overall tax burden since it increases the New Jersey tax bite but does not reduce the tax that is paid to other taxing jurisdictions.
In a move to make the State of New Jersey more business friendly and attract businesses (which creates jobs in New Jersey), the legislature passed and Governor Jon Corzine signed into law on December 19, 2008 the repeal of both of these rules effective for tax years beginning on or after July 1, 2010. For calendar-year businesses, the new law becomes effective for the 2011 calendar year. The repeal of both of these provisions has the effect of limiting the tax bite for New Jersey contractors to only that amount of business performed in New Jersey. This provides greater relief than the credit mechanism. Being able to apportion where the businesses were previously prevented is like a breath of fresh air. Compounding the relief is the reduction of the fraction as the denominator no longer needs to be reduced for sales to states the business does not file in.
Adding more wind to the sails of New Jersey contractors are two provisions recently signed into law by Governor Chris Christie. The first involves the way income is apportioned to New Jersey. As mentioned above, New Jersey, like most states, has used a three factor formula to compute how much income that a multistate business must apportion and becomes taxable to the State of New Jersey. The three factors are property, payroll and sales. Construction, by its very nature, is very labor intensive as it is capital intensive in the form of expensive heavy construction equipment. The inclusion of property and payroll has the effect of punishing New Jersey contractors for their investment in equipment necessary to execute a construction contract. Further punishment is inflicted in requiring the payment of union wages with its attendant benefits. It is easily apparent that a multi-state contractor based in New Jersey will end up with a larger fraction of income apportioned to New Jersey.
The current legislation eliminates the property and payroll components to the factor in a series of phases starting in 2012. When fully phased in, for years beginning January 1, 2014, the apportionment computation will be just the sale factor alone. This provision will provide relief to New Jersey-based contractors by apportioning to New Jersey a smaller percentage of their income since the huge investment in property and skilled labor is ignored. This change combined with the throwout and regular place of business repeals provides a large measure of relief and will have a huge effect on New Jersey contractors.
Governor Chris Christie signed into law a second piece of legislation designed to help those contractors who operate as sole proprietors. Individual taxpayers, until now, were required to report income according to the 16 classifications set up in the income tax statutes. Losses in one class may not offset income in another class. The current legislation, effective for years beginning on or after January 1, 2012, partially allows for an offset to occur. The new legislation allows business income to be offset against business income from another class. What this means is that a contractor that operates as a sole proprietorship and is a partner in another construction business will be allowed, beginning with his or her 2012 NJ-1040, to offset the income from one business against the losses from the other.
From a tax perspective the business climate has changed materially for construction contractors. With the downturn in the economy many construction projects have either been deferred or canceled entirely. This has presented a huge challenge for the New Jersey construction contractor community to survive. But all is not lost. It is the goal of the recent legislative changes to provide desperately needed tax relief in the near term as it also helps position construction contractors so that they can really benefit when the long awaited economic turnaround arrives.
For further information please contact international tax expert Dave Springsteen at HLB member firm WithumSmith+Brown, New Jersey.
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WithumSmith+Brown is a member of HLB International. Founded in 1974, WithumSmith+Brown is one of the largest regional public accounting and consulting firms along the mid-Atlantic corridor. With corporate headquarters based in Princeton, the firm has additional offices in Cherry Hill, New Brunswick, Somerville, Morristown, Red Bank and Toms River, NJ; Newtown and Philadelphia, PA; New York City, NY; Silver Spring, MD; Aspen, CO; and West Palm Beach, FL. WS+B is also a member of HLB International, HLB International is a world-wide network of independent professional accounting firms and business advisors. With 375 employees, WS+B ranks among the top 40 CPA firms nationwide and in the top 10 in New Jersey.
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