New Jersey Tax Bill a Major Step Backward for Recovery Efforts

Following the passage of the Tax Cuts and Jobs Act in 2017, several states applied the federal global intangible low-taxed income structure to their own income tax regime. Some states adopted the structure with additional credits or deductions. Others tied themselves to the federal plan so that changes would flow through.

New Jersey adopted GILTI with a 50% permitted exclusion and allowed for deductions under Section 250 of the tax code for both GILTI and foreign-derived intangible income.

If proposed bill SB 3737 becomes New Jersey law, that 50% permitted exclusion would be expanded to 95%—matching the exclusion rates of neighboring Connecticut and New York, and cutting by a factor of 10 the amount of income to which GILTI is applied.

While it may be de rigueur among some of its fellow Mid-Atlantic states, this move contravenes President Joe Biden’s 2024 proposed budget, which would see an expanded GILTI regime, including an increased rate and a reduction in exemptions.

As the state looks under GILTI’s hood and fiddles with the wires, it should consider expanding the structure to include tangible and intangible assets, rather than gutting it in a misguided attempt to attract corporate dollars.

Underlying Policy Logic

The new policy is defended on the basis of it being in line with its geographical neighbors—which makes little sense when the emphasis is on highly mobile assets and the profits derived from them. GILTI was explicitly crafted to target assets that can easily be moved to low-tax jurisdictions.

When the policy goal is to repatriate funds being offshored half a world away, trying to ensure a state’s tax regime is in line with the states it borders is completely irrational. New Jersey needn’t be competitive with New York and Connecticut any more than it needs to be competitive with corporate-focused Delaware, which includes GILTI at 50% in the same way New Jersey did before this proposal. And when New York moved to 95% exclusion, New York City explicitly didn’t, and adopted its own regime with no exemption of controlled foreign corporation income.

New Jersey hopes to make up the revenue shortfall by changing allocation factors for corporate filers, adopting the economic nexus threshold established under South Dakota v. Wayfair, and ending special tax treatment for real estate investment trusts. These are all worthy policy proposals, but with no bearing on the propriety of gutting the GILTI regime.

Under the proposed allocation factor changes, the state would go from only including New Jersey receipts when a company itself is subject to the state’s business tax regime, the “Joyce” method, to the “Finnegan” method, where New Jersey receipts would be included if any connected firm of the corporation is subject to the state business tax.

The simultaneous relaxing of GILTI and clamping down through Wayfair and the Finnegan rule suggests an overall pursuit of revenue lost to other states, and a relinquishment of profits lost to low or no-tax jurisdictions abroad—a strange policy.

Vehicles travel along roads in Newark, N.J., on June 17, 2021.

Photographer: Victor J. Blue/Bloomberg via Getty Images

GILTI for Tangibles

Expanding global intangible low-taxed income to include income from tangible assets as well—a global low or not-taxed income system—would be a much more sensible proposal both for New Jersey and at the federal level. Thus, whether the profit derived from the factory or the intellectual property the factory is manufacturing from, it would be subject to the GILTI regime and rates.

The policy rationale for focusing on income from intangible assets (rather than all assets) is the relative mobility and portability of intangibles. Taking intellectual property as an example, a patent can easily be moved to a low or no-tax jurisdiction, whereas something tangible such as a factory isn’t easily shuffled around the globe chasing tax savings.

GILTI historically has targeted the most easily relocated profits, but it carried a built-in problem in how one defines what constitutes income from an intangible asset as against a tangible one. Continuing our example, let’s say the tangible asset (the factory) is producing widgets protected by some sort of intellectual property consideration, such as a patent or trademark—an intangible asset. Determining the percentage of profits that arise from the intellectual property as against the factory isn’t an exact science.

The current GILTI regime approximates this number by arbitrarily setting an expected profit percentage on tangible assets and assuming anything above that as intangible income. Approximations are never a first choice; they’re a compromise between administrative feasibility and a desire for precision. By New Jersey’s own policy logic in its attempt to be competitive with surrounding states, the concern appears to be no longer about the mobility of intangible assets—so there’s no need to continue the ruse.

Engaging in these favorable tax treatment battles with neighboring states is a race to the bottom. The only winners are the multinational companies that are residents of convenience and stay only until another state offers them a better deal.

If New Jersey wants to increase revenue, it can do so by closing loopholes that allow multinational corporations to shift their profits to low-tax jurisdictions. A priority of ills must be considered, but New Jersey seems to be focusing on protecting revenue lost to its fellow states rather than low or no-tax regimes abroad.

Look for Leahey’s column on Bloomberg Tax, and follow him on Mastodon at @andrew@esq.social.