How Will New Jersey Legislation (A5323) Affect Financial Services?

On July 3, 2023, New Jersey enacted comprehensive tax legislation (A5323) that will likely impact every business in one shape or another. As we’ve previously written about, although a significant portion of the bill impacts corporations, this legislation undoubtedly will affect financial service businesses who are taxed as partnerships. This includes investment management companies, such as investment advisors, hedge fund managers, mutual fund service providers, broker-dealers, and similar financial service businesses.

For background, in 2019, New Jersey implemented Corporate Business Tax (CBT) reform, which adopted market-based sourcing for the receipt of services. This meant that for purposes of calculating multistate taxable income, businesses would use a “customer approach” in assigning receipts to the state for apportionment purposes. This resulted in C corporations and S corporations sourcing receipts to New Jersey if the benefit of the service is received at a New Jersey location. At the time, the use of “cost of performance” sourcing remained unchanged for Gross Income Tax purposes (i.e., partnerships and sole proprietors).

One of the most significant changes of A5323 is that partnerships and sole proprietors are required to retroactively use the same apportionment and sourcing rules as corporations. This results in the elimination of a 3-factor apportionment formula, thereby adopting a single sales factor (SSF) formula, in addition to market-based sourcing (MBS) for service providers. As SSF/MBS is effective January 1, 2023, the provision includes estimated tax penalty and interest relief for qualifying taxpayers.

For New Jersey financial service-centric businesses with a multistate customer base and substantial ownership residing outside the state, this may result in a reduction of New Jersey tax. However, out-of-state businesses with New Jersey investors/clients may find themselves with an increase in New Jersey tax.

The state’s CBT regulations apply a hierarchy set of rules in sourcing receipts as such: If the benefit of a service is received in multiple states, the portion of the receipts allocated to New Jersey is based on the percentage of the total value of the benefit received in New Jersey, or a “reasonable approximation” of that value.

For individual customers, when this cannot be determined, the benefit of the service is deemed to be received at the customer’s billing address. For business customers, when this cannot be determined, the benefit of the service is deemed to be received at the location from which the services were ordered. However, if the order location cannot be determined, the benefit of the service is deemed to be received at the business customer’s billing address.

Furthermore, New Jersey applies special “asset management services” sourcing rules. The state broadly defines asset management services and sources receipts based on services provided to as such:

As the legislation specifically ties apportionment rules to the CBT statute, it is anticipated such asset management sourcing rules will apply to financial service businesses organized as a partnership that derives such revenues.

However, even if a financial service business doesn’t meet the “asset management services” rules, it will be important for businesses to consider if a look-through type rule should still apply and/or how the hierarchy customer-location sourcing rules should apply. This is due to many states using “look-through” provisions, sourcing receipts to the party that received the ultimate benefit of the taxpayer’s services. With respect to New Jersey’s hierarchy customer-location sourcing rules, the state doesn’t explicitly apply look-through rules, but some of the examples found within the regulations imply the state’s interpretation is that look-through rules may apply in certain instances. However, as market-based sourcing rules in New Jersey are relatively new, much of this remains fluid.

With the passage of A5323, out-of-state financial service businesses may find themselves with a New Jersey state filing requirement as a result of economic nexus. Likewise, financial service businesses will need to consider if complex “asset management services” sourcing rules apply to them. In addition, with the elimination of the 3-factor apportionment formula, there will be no reliance on payroll and property, which will affect businesses overall New Jersey tax based on their facts and circumstances.

Furthermore, businesses will need to consider the potential impact to their Pass-Through Business Alternative Income Tax election (BAIT). Provided New Jersey BAIT conforms to CBT rules, in-state businesses may find themselves with significantly less deductions as part of their “SALT workaround” planning. As such, businesses may want to consider possibly electing in other states but should weigh all the potential benefits along with the risks.

As businesses analyze the potential impact of the legislation, they should also monitor for any subsequent guidance from the Division of Taxation.