This past weekend, as part of passing New Jersey’s 2019 budget, Governor Murphy signed into law a series of changes to the state tax laws. These changes have will have a disproportionate effect on the state’s highest earners and corporations. These affected taxpayers will undoubtedly look for alternative structures to mitigate the impact of the new laws.

This relatively small group of high earners pegged to contribute to this spending plan is still reeling from the stunning blow delivered to New Jersey residents by Congress through the virtual elimination of the SALT deduction. The only question that remains is how many members of that group will seek refuge to states that do not levy a personal income tax and have much lower property and franchise taxes.

How these aggressive tax policies will attract new corporations and high net worth persons to New Jersey is also of significant concern for the state’s long-term fiscal growth and prosperity.

Below is a list of changes to the Gross Income Tax, Sales Tax, Corporate Business Tax and a new Tax Amnesty Program that are intended to increase revenue to pay for the state’s new spending plan.

Gross Income Tax

  • Top income tax bracket of 10.75 percent for income exceeding $5 million.
  • Employers that are subject to the state’s income tax withholding requirements to withhold 15.6 percent on salaries and wages in excess of $5 million for tax year 2018.
  • Eliminates an exclusion from New Jersey source income (for nonresidents) for carried interest/income from providing investment management services and imposes a 17 percent surtax on such management income for Gross Income Tax and Corporation Business Tax purposes.
  • Eliminates tax exemption provided to pass-through entities receiving and selling Grow New Jersey credits.

Sales Tax

  • Sales tax nexus of: $100,000 in taxable sales or 200 or more separate transactions.
  • Sales tax collection and reporting requirements on a “marketplace facilitator,” which is defined to mean any person or business that provides a forum to a retailer to advertise, promote and list the retailer’s products and that also collects receipts from the customer and remits payment to the retailer.

Corporation Business Tax (CBT)

  • For corporations with allocated net income of more than $1 million annually other than public utilities, the new law imposes a surtax of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019 and 1.5% for tax years beginning on or after January 1, 2020 through December 31, 2021.
  • For tax years beginning after December 31, 2016, the 100% dividends-received-deduction (“DRD”) for dividends paid to the taxpayer by one or more subsidiaries owned by the taxpayer (if more than 80% ownership defined by voting power) is reduced to 95 percent for 80 percent-owned subsidiaries.
  • The law also only allows a deduction for interest paid to a foreign related member if the related member is in a foreign country with a comprehensive US tax treaty in place and is subject to tax in the foreign country at an effective rate within three percentage points of the New Jersey rate.
  • The law changes the sourcing rules for certain service providers that operate in and out of New Jersey. Under the new law, the service is sourced to the location where the benefit is received and not where the service is performed. If the benefit is received in more than one state, reasonable approximation may be used. For individuals, the default sourcing rule is the customer’s billing address; for others it could be the location from where the services are ordered in the customer’s regular course of operations or the billing address if the location from where the order was made is unavailable.
  • No deduction is allowed for the deduction under IRC Section 965. This section requires a taxpayer to be taxed on a deemed dividend for deferred foreign income and provides for a deduction to achieve the lower repatriation tax rate. This deduction will not be relevant to the calculation of CBT. Likewise, the deduction provided in new IRC Section 199A, which acts to minimize income from flow-through entities, will have no effect on the CBT. Aside from clarifying the states’ position on these Federal changes, these will ensure that there is no reduction in revenue because of the new Federal tax laws.

Tax Amnesty

  • A 90-day tax amnesty period to run through no later than January 15, 2019.
  • Under the new amnesty program, any taxpayer with liabilities for returns due on or after February 1, 2009, can pay the tax, plus half the interest due as of November 1, 2018 and avoid any penalties with the exception of criminal and civil fraud penalties.

Many of our clients are evaluating the impact of the latest tax changes by asking their accountants to run individual and corporate projections to assess the impact for 2018, 2019 and beyond. Many are also contemplating taking up residence in lower tax jurisdictions such as Florida.

Our next blog post will detail the feasibility of achieving non-resident status (only paying tax on New Jersey source income) while maintaining a residence in New Jersey, but avoiding New Jersey tax on your worldwide income by becoming a permanent resident of Florida.

 

With the continued proliferation of online sales projected to reach $414 billion by the end of 2018, the states, eager to capture their share of this online revenue, have reached for businesses that have no physical contact with the state.

Until the U.S. Supreme Court’s ruling last week in South Dakota v. Wayfair, 2018 WL 3058015 (Sup. Ct. June 21, 2018), physical contact was the traditional hallmark for establishing “nexus.”  Nexus is the link between an out-of-state business and a given state that provides that state with the jurisdiction under the U.S. Constitution to impose sales tax on businesses participating in inter-state commerce.

The Supreme Court finally caught up to the changing market place last week overturning in Wayfair the “physical presence” test established in Quill Corp. v. North Dakota, 504 U.S. 298 (1992).  The Court ruled that the physical presence test is “unfair and unjust” to the brick and mortar businesses competing against virtual competitors.  To level the playing field, South Dakota passed an “economic nexus” law requiring out-of-state sellers to collect sales tax if they derive more than $100,000 of gross revenue from the state or conduct more than 200 transactions in the state.  South Dakota prevailed on the constitutional challenge brought by the e-commerce company Wayfair even though the law imposed sales tax without requiring a business to have physical presence in the state.

The Court in Wayfair expressed that the states should be allowed to “seek long-term prosperity” through economic nexus legislation (estimates indicate the physical presence test has cost states billions of dollars in uncollected sales tax).  In fact, many states’ laws had already blurred the once bright-line Quill physical presence rule.  For example, New York passed click-through nexus legislation in 2008, creating a presumption of physical presence for online retailers that had referral agreements with residents of the state as a result forcing online retailers to collect sales tax on New York shipments.  The online retailers Overstock and Amazon challenged this law but it was upheld by New York’s highest court.  In the aftermath of this decision, New Jersey passed its own similar law and also entered into a tax collection and job creation agreement with Amazon.  The online giant conceded having nexus with the state and then, as an apparent concession, built fulfillment distribution centers in New Jersey in conjunction with collecting sales tax on its online sales.

Under this new Supreme Court precedent, New York, New Jersey and other states do not need to prove physical presence by indirect means, but can move forward with implementing legislation to directly impose sales tax on online businesses on receipts generated from the state.

In light of the Supreme Court decision and the liberation of the states from the yoke of the physical presence test, online and other hybrid businesses should not delay conducting “nexus studies” of their business practices, which we regularly conduct for our clients.  This helps companies determine and plan for potential exposure in an audit, including the personal liability exposure for owners and officers for uncollected sales tax that is not dischargeable in bankruptcy.

 

While success in crypto-currency investing is far from assured, death, sadly, is.  Accordingly, it is vital that investors in Bitcoin and other crypto-currencies are prepared for the unique estate planning factors that apply to digital assets.  The following are five estate planning factors that should be addressed immediately by crypto-currency investors to ensure that their digital assets are effectively passed on to their heirs or beneficiaries.

  1. Custody of Private Keys and Other Information to Access Digital Assets

Unlike bank accounts which can be accessed post-mortem, digital assets typically require a variety of private information to be accessed.  This information (and an investor’s digital assets) may be lost forever if an investor fails to record it or share it with a trusted third party before they die.  To avoid this, it is crucial that investors physically record the following private access information and provide for custody of this information in their will:

  • Private Key: Most crypto-currencies use a public-private key system to ensure that transactions are valid.  While the public key is made public every time the investor buys or sells crypto-currency, only the investor knows the private key.  Private keys are essential to verify ownership and access digital assets, and should be recorded.  Gaining access to a private key is similar to gaining ownership of a bank account, so it is vital that private keys are kept safe.  Creating a physical copy of your private key and securing it in a bank safety deposit box insulates your private key from hacking and may provide the safest means to protect it.
  • Passwords: Crypto-currencies are traded on online platforms commonly known as exchanges.  Investors that fail to secure their digital assets in hardware wallets (see below) typically have their crypto-currencies stored on default digital wallets provided by an exchange.  It is important that the username, password, and security question information for exchanges be recorded to retrieve digital assets from exchange wallets.
  • Two-Factor Authentication: Many crypto-currency exchanges also require that investors use two-factor authentication to authenticate their identity when accessing their account and transferring digital assets.  Two-factor authentication is typically accomplished via a mobile application that provides a unique code to be entered into the exchange.  Investors who use two-factor authentication should record their username, password, and security question information.
  1. Custody of Hardware Wallets

Once Bitcoin and other crypto-currencies are purchased on an exchange, they are automatically stored on that exchange’s default wallet where they can be accessed electronically by the investor.  Digital wallets, especially those used by exchanges, are susceptible to hacking. Investors should transfer their digital assets to a hardware wallet.  Hardware wallets can be purchased online and are, generally, encrypted flash drives that require a password to be accessed.  Investors and their heirs may lose their digital assets if their hardware wallet is lost or damaged.  Investors should record the password and other access information for their hardware wallets, and provide for custody of the information and the wallet itself in their will.

  1. New Jersey Uniform Fiduciary Access to Digital Assets Act

In 2017, New Jersey enacted the Uniform Fiduciary Access to Digital Assets Act (the “Act”).  The Act generally enables individuals to appoint a fiduciary to manage their “digital assets”, broadly defined as electronic records.  Under the Act, electronic records include account information for online exchanges.  Unfortunately, while the Act authorizes a fiduciary to access a deceased investor’s exchange account, it fails to consider that the private key – the essential information to remove digital assets from a digital wallet – is not available to exchanges.  Moreover, the Act’s limited applicability to electronic records may exclude its applicability to hardware wallets.

  1. Fiduciaries under Power of Attorney and Will

Under a well drafted Power of Attorney, an agent, appointed by the principal, is given the power to manage the principal’s assets and make investment decisions on behalf of the principal.  Depending on how the document is drafted, the powers granted under the Power of Attorney can either be effective immediately upon execution or only effective upon the disability or incapacity of the principal.  Having such a document avoids the necessity of asking the court to appoint someone as the principal’s guardian if he or she cannot manage his or her own affairs.

Among other things, the executor of an estate is tasked with distributing the property of the decedent in accordance with the decedent’s will.

In the context of Bitcoin and other crypto-currencies, it may be necessary for the agent under a Power of Attorney or the executor of an estate to have control over these assets.  As such, it is critical that an owner of crypto-currency have a well drafted Power of Attorney and Will, specifically providing the agent with authority over the crypto-currency assets and the necessary information to access such assets.

  1. Estate Planning with Crypto-Currencies

The federal estate tax is based on the value of one’s assets less liabilities at one’s date of death and is imposed at a rate of 40%.  One important exception that is critical to understanding how the federal estate tax works involves the estate and gift tax exemption.  This exemption is the amount that one can transfer to anyone during one’s lifetime or at death without incurring a gift or estate tax.  In 2018, the exemption is $11.18 and this amount will be indexed annually for inflation until 2026, when the exemption amount is scheduled to revert to $5.49 million, with an adjustment for inflation.

For wealthier owners of crypto-currency assets, implementing certain estate planning techniques in order to remove the value of these assets from his or her estate could be highly beneficial.  One such technique would be the creation of a limited liability company (“LLC”), funding the LLC with crypto-currency assets, and then gifting most of the economic value of the LLC to a family trust.

The gift would use a portion of the owner’s federal gift tax exemptions and thus no federal gift tax would be due.  Additionally, if the LLC is created with voting and non-voting membership interests and only the non-voting interests are transferred to the family trust, the value of the gift could be discounted for gift and estate tax purposes.  Moreover, all future appreciation on the value of the LLC interests gifted would accrue outside of the transferor’s taxable estate.

Investors in crypto-currencies are at risk of losing their assets at death unless they plan ahead.  Following these five factors and speaking to an estate planning attorney versed in crypto-currencies will help ensure that digital assets are effectively passed to heirs or beneficiaries.

On March 13, 2018, the IRS announced that the Offshore Voluntary Disclosure Program (OVDP) will be closing on September 28, 2018. This program has been in place since 2009.

In general, US persons, that is, citizens and residents of the US, must report their worldwide income on their US income tax returns. They also must report their financial accounts held outside the US on an annual FBAR (FinCEN Form 114) if the aggregate balance of their accounts exceeds $10,000.

The OVDP offers a structured program for taxpayers to amend income tax returns to report any unreported foreign income, submit any unfiled international tax filings, and disclose the existence of financial accounts outside the United States.

To participate in the OVDP, taxpayers have had to pay a substantial civil penalty based on the value of the unreported accounts, in addition to paying back taxes with a 20% penalty and interest.

The incentive to participating in the OVDP is that the IRS will not criminally prosecute the taxpayer for the failure to report his or her accounts and that all other potential civil penalties will not be assessed in lieu of the one OVDP penalty.

The OVDP is intended for those taxpayers who knew that the law required reporting of their foreign accounts but who decided to not report such accounts on an FBAR or on other international tax filings. These taxpayers have the most to gain from participating in the OVDP and remain exposed if they choose to not come into compliance.

The OVDP requires eight years of amended return filings, six years of FBAR filings, as well as several other items to be submitted to the IRS. The IRS requires a complete OVDP submission by the September 28 deadline. These submissions require time to compile the necessary documentation and to prepare amended returns. It is important for those not in compliance to decide on participating now – well before the September deadline – or you will not be able to complete the OVDP.

What options do taxpayers have if they didn’t file FBAR’s or report their foreign income but their mistakes were inadvertent? This is referred to as a “non-willful” case and is common for many taxpayers who have accounts from their home country that were opened before moving to the US or for those whose tax return preparer did not advise them as to what the tax law requires. The IRS is continuing a program known as “Streamlined Filing Compliance Procedures,” for non-willful violations. These procedures, which may also require a penalty, will continue past September. There are also other ways to return to compliance.

What will IRS enforcement in this area look like once the OVDP is ended? We believe that examinations in this area will only increase. The IRS has gathered a decade’s worth of material on foreign institutions and bankers through the OVDP. This data, along with the information that the IRS now receives from many foreign countries pursuant to a law known as FATCA, allows the IRS to identify non-compliant taxpayers much more easily today than in the past. These international audits are quite intrusive and can expose taxpayers to substantial penalty. We expect the number of these audits to increase.

Once the OVDP option has ended, taxpayers will still be able to voluntarily come forward to disclose past misdeeds. (The IRS has stated that the precise details how to do so will be forthcoming.) It is clear, though, that as onerous as the OVDP penalty is now, the toll to come into compliance in the future will only be greater.

The recently enacted 2017 tax act (originally called the Tax Cuts and Jobs Act – “Tax Reform Act”) contains sweeping changes to US international tax rules that will affect international  businesses and cross border investments.   A review of how to take advantage of these new rules can reap significant benefits or avoid tax pitfalls, as discussed below.

New Territorial Tax System

The Tax Reform Act adopts a new territorial system of taxation (also known as a participation exemption system), which may eliminate or reduce US income taxes on income earned outside the US by US C corporations (“C corps”).  If a C corp owns 10% or more of a foreign corporation that pays a dividend, then the C corp receives a 100% dividends received deduction (“DRD”) for the foreign source portion of the dividend, which will eliminate or reduce the US tax imposed on the dividend.  This DRD is only available for C corps and not for S corporations or individuals.

A DRD will not apply if the foreign corporation is a passive foreign investment company (“PFIC”) unless the foreign corporation is also a controlled foreign corporation (“CFC”) as discussed below.  A PFIC is a foreign company whose income predominantly comes from passive investments (such as marketable securities).

The new territorial system does not apply to income earned by a C corp from a foreign branch.  Income from a foreign branch is subject to US tax, although if foreign tax is imposed on that income, then a foreign tax credit may reduce or eliminate US tax.  As a result, businesses that operate as C corps may want to incorporate their foreign branches to eliminate US tax on branch income.

This system also can reduce the taxable gain realized when a C corp (but not an S corporation or an individual) sells the stock of a foreign corporation.  If the C corp owns the stock of a foreign corporation for one year or more, pre-2017 law recharacterizes any amount realized by the C corp on the sale as a deemed dividend to the extent of the accumulated earnings and profits of the foreign corporation.  The Tax Reform Act provides that such deemed dividend is eligible for the participation exemption system and thus, is not subject to tax.  As a result, a US C corp can eliminate part or all of the taxable gain on the sale of stock of a foreign subsidiary.

New Global Intangible Low-Taxed Income (“GILTI”) Tax

While labeled a tax on intangible income, the GILTI tax is actually a current tax imposed on US shareholders of CFCs on their share of any income earned by the CFC that exceeds a 10% return on investment.  A CFC is any foreign corporation if US shareholders own more than 50% of its stock; for this purpose, a US shareholder is any US person who owns 10% or more of the voting stock or value of the stock of the foreign corporation.  If a CFC has certain types of passive income known as Subpart F income, then US shareholders must include in their income their share of the Subpart F income even though no dividend is paid to them.

The Tax Reform Act provides that a US shareholder of any CFC must include in gross income, for a taxable year, its GILTI in a manner generally similar to the inclusion of Subpart F income.  GILTI means the excess of the shareholder’s net CFC tested income over the shareholder’s net deemed tangible income return in that CFC.  The shareholder’s net deemed tangible income return is an amount equal to the excess of 10% of the aggregate of the shareholder’s pro rata share of the qualified business asset investment (“QBAI”) in that CFC over certain interest expense of each CFC with respect to which it is a US shareholder.  The QBAI is essentially a book value concept since it is based on the tax basis of the CFC’s assets and not their fair market value.  As a result, the 10% threshold can easily be exceeded.

US shareholders who are C corps are given special tax benefits that can eliminate the GILTI tax.  First, under the new law, a C corp can deduct 50% of the GILTI inclusion amount, which reduces the potential corporate tax from 21% to 10.5%.  Second, for any amount of GILTI included in the gross income of a C corp, the C corp would be deemed to have paid foreign income taxes equal to 80% of the foreign taxes paid by the CFC with respect to such income.  If the CFC pays foreign taxes of 13.125% or more, then this special foreign tax credit will eliminate any GILTI tax.  Individuals and S corporations get no similar treatment and pay full US tax on any GILTI inclusion amount.

Conclusion

US taxpayers should carefully review the structure of their foreign entities with their advisors to determine if the new territorial tax system may apply to them, and whether any foreign corporations may qualify as CFCs, which will subject their US shareholders to the new GILTI tax as well as numerous other rules affecting CFC shareholders.  Since the Tax Reform Act limits the benefits of the new territorial tax system to C corps and also only allows C corps benefits to eliminate the GILTI tax, US taxpayers should consider owning foreign stock in a C corp.  Individuals who own foreign corporate stock may want to transfer such stock to C corps; S corporations owning foreign corporate stock also may want to restructure to take advantage of these new rules.  While this task may not be simple, the tax benefits may significant.