Tax competition has been a major focus of state policy in recent years, and although New Jersey did not initially join this trend, both the governor and those in the legislature (through Assembly Bill 5323) now have fiscal policy in mind. Of the ideas on the table, allowing the corporate surtax to lapse and removing Global Low-Tax Intangible Income (GILTI) from taxes would make New Jersey more competitive. While extending the net interest limitation to all members of unitary groups is normal for a Finnigan rule state, doing so without adopting full expense would perpetuate an onerous part of the corporate tax code.
When it comes to tax competition, New Jersey has historically been at the bottom of the pack. As of 2014, the Garden State has ranked last in the State Business Fiscal Climate Index—a measure of the competitiveness of state tax codes—seven times and ranks 49thhe in the years he was not ranked 50he. While 24 states adopted permanent tax relief in 2021 or 2022 by lowering individual or corporate income tax rates, New Jersey has offered only one-time sales tax rebates and exemptions. But this pattern does not have to continue. Policymakers should use the current discussions as an opportunity to improve New Jersey’s tax code and make the state a true competitor.
The Corporate Income Surcharge
The New Jersey business income tax is an outlier among states, both in rates and structure. The Garden State’s corporate income tax rate of 11.5 percent has been the highest in the country since 2021, when Iowa lowered its top rate from 12 percent to 9.8 percent. Additionally, New Jersey’s bracket structure differs from other states because rates are applied to a corporation’s entire net income, rather than just income above each rate threshold.
In 2018the New Jersey legislature installed a temporary 2.5 percent surtax on businesses (Not included partnerships or S corporations), which raised the rate from 9 to 11.5 percent for businesses with revenues greater than $1 million. The additional tax was set to expire at the end of the 2021 tax year. However, at the end of 2020, the legislature decided to extend the surtax through the end of the 2023 tax year, citing revenue concerns arising from the pandemic.
Governor Murphy has expressed his desire to let the additional tax expire at the end of 2023. If he gets his wish, New Jersey’s top corporate income tax rate would drop to 9 percent, putting the state below Alaska, Illinois and Minnesota. Although the rate is still high compared to the rest of the states, meeting the promised surtax expiration would be a step in a more competitive direction.
Elimination of GILTI taxation
After the Tax Cuts and Jobs Act (TCJA), many states inadvertently included GILTI in their tax bases by complying with the federal tax code. However, excluding GILTI is an important move, as such revenues are beyond the traditional reach of state taxes and discourage multinational companies from working in the state.
A GILTI tax is essentially a tax on excess income abroad, which is designed to be a substitute for a tax on intellectual property or other intangible business assets. At the federal level, these taxes are designed to minimize tax avoidance and profit shifting, and there is a 50 percent deduction under IRC section 250 and plus credits for foreign taxes paid to reduce the tax on such income. However, states like New Jersey, which begin their business income tax calculations with federal taxable income before special deductions (line 28 of the business income tax form), generally waive the deduction. corresponding 50 percent, inadvertently taxing this income more aggressively than the federal government does. .
Under A5323, New Jersey would treat GILTI as a dividend effective August 1, and accordingly allow companies to exempt it from income. Kansas most recently joined 26 other states that do not include GILTI in the corporate tax base or do not impose a corporate income tax. If New Jersey did the same, it would start to reduce its abnormally large tax burden on businesses.
Net Interest Deduction Limitation and Comprehensive Expenses
The creation of the net interest deduction limitation, found in Section 163(j), at the federal level, was intended to help pay the costs of implementing full expenditures under Section 168(k) . It should be noted that while New Jersey does not comply with the pro-investment spending provisions, the state does comply with Section 163(j) revenue collection. Through the process of changing the Joyce to Finnigan rules for combined reporting, Assembly Bill 5323 would extend this limitation to combined groups as a whole.
This tax treatment is not new to Finnigan rule states. However, if New Jersey continues to comply with Section 163(j), the state should also allow companies to fully expend capital investments in the year they occur, adopting the original pro-growth policy that prompted the cap. of net interest first.
Generally, when businesses calculate their income for tax purposes, they subtract business costs. This is appropriate, since the corporate income tax is intended to be a tax on business profits, generally revenues minus costs. Requiring these deductions to be spread out over multiple years, as is the case in New Jersey, changes the nature of the tax.
Due to inflation and the time value of money, a dollar in the future is always worth less than a dollar today. Delaying deductions for the cost of business investments means that the actual value of the deductions will always be less than the original cost. Ultimately, this treatment means that corporate income tax is biased against capital equipment investment, since other business expenses (for example, labor, advertising, and supplies) can be written off in the first year. This is especially damaging for companies in equipment-intensive manufacturing industries.
Although 18 states currently conform to the federal capital investment treatment, the impact begins to erode this year with the federal elimination of spending altogether and its eventual extinction. Last year, Oklahoma became the first state to make full spending permanent, and Mississippi followed suit this year. Policymakers in other states have also expressed interest in staying, raising hopes that many more states may follow suit next year. New Jersey should consider getting ahead of its peers by not only adopting this pro-growth policy, but also making it permanent.
Lessons and Solutions
At a time when businesses and residents are more mobile than ever, New Jersey isn’t holding up well against the competition. The Garden State has been plagued by out-migration in recent years, with many residents in 2019 packing up to head nearby. states like Pennsylvania and New York, but also to lower-tax states further afield, like Florida and North Carolina.
As the saying goes, the best time to plant a tree is 20 years ago, but the second best time is today. Just because New Jersey has had an onerous tax code for many years doesn’t mean it’s too late to improve. The last two years have shown that state tax reform is possible and important; New Jersey can also accept this possibility. By allowing the corporate surtax to lapse, eliminating the GILTI tax, and accepting full spending, New Jersey would take important steps to create a more welcoming and competitive tax environment.