New Jersey is taking an aggressive new stance to raise taxes on foreign income from multinational companies.
Johnson & Johnson and Merck & Co. Inc. are the largest companies headquartered in the state, but even companies not based there could be affected.
New Jersey is including a new federal category of foreign income in its tax base, and is the first state to tax 50 percent of that income, while choosing to grab its share of the income pool through a special—and surprising—calculation involving its gross domestic product. Lobbying groups, like the State Taxes After Reform (STAR) Partnership and the Council on State Taxation (COST), are up in arms to stop states from following New Jersey and adopting similar approaches.
“New Jersey has taken an extreme position in conforming to the new federal tax law,” said Joseph R. Crosby, chief executive officer at government affairs firm MultiState Associates Inc. At issue is a new tax on global intangible low-taxed income (GILTI) designed to stop companies from shifting profits offshore and ensure that they pay something on overseas profits earned in low-tax jurisdictions.
Higher state tax liabilities might even be enough for companies to move their operations elsewhere. “It’s a mistake for states to think that companies are stuck and that they can raise taxes without any impact to their resident companies,” Andrew Silverman, a Bloomberg Intelligence tax policy analyst, said in an email to Bloomberg Tax.
But Bruce J. Fort, senior counsel at the Multistate Tax Commission, said the higher state tax liability for companies shouldn’t be a big factor in deciding business locations, because states are focusing more on customers and moving toward sales-based taxation.
A new bill in the state Legislature could at least reduce the tax burden.
A group of New Jersey Assembly Democrats introduced a bill Feb. 14 that would reduce the amount of GILTI they have to record for state tax purposes: 90 percent instead of the current law’s 100 percent. Assemblymen Roy Freiman, Vincent Mazzeo, and John Burzichelli sponsored the measure, which was referred to the Commerce and Economic Development Committee.
Freiman, who previously worked at Prudential Financial for more than 20 years, said New Jersey’s current corporate business tax system is overreaching and needs to be fine-tuned.
“Everyone has the need for revenue, but the best way to get revenue is by growing businesses all around,” Freiman told Bloomberg Tax Feb. 22. “No one has the secret sauce. Everyone is trying to create a balance, so that’s my attempt.”
Impact on Companies
Johnson & Johnson accounted for New Jersey’s GILTI tax in its estimated 2019 effective tax rate of 17 percent to 18 percent, an executive said. That range is higher than the company’s 2018 worldwide effective tax rate of 15 percent, but New Jersey’s GILTI liability isn’t a material factor impacting the 2019 increase, said Louise Weingrod, J&J’s vice president of global taxation.
“We are committed to New Jersey, which has so much to offer businesses with its proximity to leading universities, medical research labs, and industrial resources,” Weingrod told Bloomberg Tax in an email.
“Our hope is that New Jersey will adopt competitive tax policy that invites greater investment in innovation and job creation, while also enabling The State to continue investing in supportive programs and infrastructure that makes living and working here so beneficial for its residents,” she said.
Merck and the state Treasury Department didn’t respond to requests for comment.
Outside States’ Borders
States are divided in their adoption and recognition of the GILTI tax. A batch of states have recognized the federal law’s new category of income, while some “don’t even acknowledge that GILTI exists,” said Richard Spengler, managing director of BDO LLP’s state and local tax practice. “It’s a strange thing.”
States that have recognized GILTI have decided to tax a slice of it, even though it’s earned outside their borders. States can typically choose to follow the Internal Revenue Code from a different year or they can choose to follow the new law. The states that follow the new law can decide whether they want to adopt certain provisions, such as a tax on GILTI, or offer something to companies to offset the federal tax.
The federal GILTI tax is supposed to kick in if a company is paying a low tax rate—below 13.125 percent—in foreign countries. When that happens, the U.S. applies a 10.5 percent tax to a company’s “excess” profits earned overseas through some of its foreign subsidiaries. After 2025, the overseas tax rate threshold will be 16.4 percent.
Business groups like the STAR Partnership, COST, and the Organization for International Investment have tried to steer states away from adopting the federal GILTI tax.
The Garden State is taking the most aggressive approach to taxing that income, tax practitioners told Bloomberg Tax. New Jersey has “made a lot of big statutory changes,” Fort said. “It’s attracting the most contention from taxpayers.”
Companies that owe tax to New Jersey and have a pool of GILTI must allocate a percentage of that income to New Jersey by using a special accounting method. They do so by calculating the ratio of New Jersey’s gross domestic product over the total GDP of every state they operate in.
“That was a surprise we couldn’t anticipate,” said Steve Wlodychak, a principal at Ernst & Young LLP in Washington who focuses on state and local tax issues.
If a company operates in all 50 states, the New Jersey calculation would come out to about 3.1 percent, according to New Jersey’s Dec. 24 technical bulletin. So 3.1 percent of a company’s entire GILTI income would be allocated to New Jersey for tax purposes. New Jersey would tax 50 percent of that income.
Wlodychak and Andrew D. Phillips, a principal in EY’s quantitative economics and statistics group, conducted a study for COST and the State Tax Research Institute on the federal tax overhaul’s impact on state corporate income taxes. They found that companies would see a 2 percent to 3 percent tax liability increase, on average, in states that tax GILTI and provide a related deduction under tax code Section 250.
New Jersey’s current method of calculating GILTI doesn’t work because not all companies owing tax there have on-the-ground operations in the state or a large amount of sales there, said Andrew J. Musick, vice president of government affairs at the New Jersey Business and Industry Association. It could differ from industry to industry and company to company.
“It would be financially detrimental to our members as it might not accurately reflect their actual activity in the state,” Musick said. The association represents 17,000 businesses of all sizes, including Uber Technologies Inc. and Morgan Stanley.
Unlike other states recognizing the new federal provision, such as Illinois and Connecticut, New Jersey isn’t treating GILTI as dividend income. That means income captured by the provision won’t be eligible for a state-level deduction, and corporations won’t be able to reduce the taxable income owed to New Jersey by excluding GILTI from its tax base.
New Jersey might need to prepare for legal challenges to its adoption of a GILTI tax. “It might be involved in litigation for years to come,” said Alysse McLoughlin, a partner at McDermott Will & Emery in New York. Her firm, along with MultiState Associates, represents the STAR Partnership.
Crosby, at MultiState, said he hopes New Jersey’s policy makers “will see the error in the changes” the state adopted “and seek to prioritize investment and job creation this legislative session.”