S4503

An Act allowing a deduction from New Jersey gross income of certain capital gains from sale or exchange of qualified small business stock held for more than five years, supplementing Title 54A of the New Jersey Statutes.

Be It Enacted by the Senate and General Assembly of the State of New Jersey:

1. a. Notwithstanding the provisions of N.J.S.54A:5-1, a taxpayer who is an individual shall be allowed to deduct from the taxpayer's gross income, for any taxable year beginning on or after the effective date of P.L. , c. (C. ) (pending before the Legislature as this bill), the eligible gain from the sale or exchange of qualified small business stock held for more than five years, in accordance with the maximum allowable deductions established pursuant to subsection b. of this section.

b. (1) If the taxpayer has eligible gain for the taxable year from one or more dispositions of qualified small business stock, the aggregate amount of the gain from dispositions of stock issued by the corporation which may be taken into account for the taxable year shall be determined as follows:

(a) If at least 80 percent of the corporation’s payroll, as measured by total dollar value, is attributable to employment located within this State, the taxpayer shall be entitled to a maximum allowable deduction not to exceed the greater of:

(i) $10,000,000; or

(ii) 10 times the aggregate adjusted basis of qualified small business stock issued by the corporation and disposed of by the taxpayer during the taxable year; or

(b) If less than 80 percent of the corporation’s payroll, as measured by total dollar value, is attributable to employment located within this State, the taxpayer shall be entitled to a maximum allowable deduction not to exceed the greater of:

(i) $8,000,000; or

(ii) eight times the aggregate adjusted basis of qualified small business stock issued by the corporation and disposed of by the taxpayer in the taxable year.

(c) Notwithstanding any provision of this paragraph to the contrary, the maximum allowable deduction amounts set forth in subparagraphs (a) and (b) of this paragraph shall be reduced by the aggregate amount of eligible gain taken into account by the taxpayer under this section for any prior taxable year attributable to dispositions of stock issued by the corporation. The applicable aggregate adjusted basis of qualified small business stock shall be determined without regard to any addition to basis after the date on which the stock was originally issued.

(2) For purposes of this subsection, the term “eligible gain” means any gain from the sale or exchange of qualified small business stock held for more than five years.

(3) (a) In the case of a married individual filing a separate return, the maximum deduction allowed pursuant to this subsection shall be the greater of: 50 percent of the dollar value allowed; or 50 percent of the aggregate adjusted basis allowed, pursuant to this subsection.

(b) In the case of a married taxpayer filing a joint return, the amount of gain taken into account under this subsection shall be allocated equally between the spouses for purposes of applying this subsection to subsequent taxable years.

c. As used in this section:

(1) “Qualified small business stock” means any stock in a C corporation which is originally issued on or after January 1, 2015, if both of the following apply:

(a) As of the date of issuance, the corporation is a qualified small business.

(b) Except as provided in subsections e. and g., the stock is acquired by the taxpayer at its original issue, directly or through an underwriter, in either of the following manners:

(i) in exchange for money or other property,not including stock; or

(ii) as compensation for services provided to the corporation, other than services performed as an underwriter of the stock.

(2) (a) Stock in a corporation shall not be treated as qualified small business stock unless, during substantially all of the taxpayer’s holding period for the stock, the corporation meets the active business requirements of subsection d. of this section and the corporation is a C corporation.

(b) (i) Notwithstanding subsection d. of this section, a corporation shall be treated as meeting the active business requirements of subsection d. of this section for any period during which the corporation qualifies as a specialized small business investment company.

(ii) For purposes of sub-subparagraph (i) of this subparagraph, the term “specialized small business investment company” means any eligible corporation, pursuant to paragraph (4) of subsection d. of this section, that is licensed to operate under Section 301(d) of the federal Small Business Investment Act of 1958,as in effect on May 13, 1993.

(3) (a) Stock acquired by the taxpayer shall not be treated as qualified small business stock if, at any time during the four-year period beginning on the date two years before the issuance of the stock, the corporation issuing the stock purchased, directly or indirectly, any of its stock from the taxpayer or from a related person to the taxpayer. For the purposes of this subparagraph, "related person" means a corporation, partnership, association, or trust controlled by the taxpayer; an individual, corporation, partnership, association, or trust that is in the control of the taxpayer; a corporation, partnership, association, or trust controlled by an individual, corporation, partnership, association or trust that is in the control of the taxpayer; or a member of the same controlled group as the taxpayer.

(b) Stock issued by a corporation shall not be treated as qualified small business stock if, during the two-year period beginning on the date one year before the issuance of the stock, the corporation made one or more purchases of its stock with an aggregate value, as of the time of the respective purchases, exceeding five percent of the aggregate value of all of its stock as of the beginning of the two-year period.

(c) If any transaction is treated under section 304(a) of the Internal Revenue Code (26 U.S.C. s.304(a)) as a distribution in redemption of the stock of any corporation, for purposes of subparagraphs (a) and (b) of this paragraph, the corporation shall be treated as purchasing an amount of its stock equal to the amount treated as a distribution in redemption of the stock of the corporation under section 304(a) of the Internal Revenue Code (26 U.S.C. s.304(a)).

(4) “Qualified small business” means any domestic corporation, as defined in section 7701(a)(4) of the Internal Revenue Code (26 U.S.C. s.7701(a)(4)), which is a C corporation, if all of the following apply:

(a) The aggregate gross assets of the corporation, or any predecessor thereof, at all times on or after the effective date of P.L. , c. (C. ) (pending before the Legislature as this bill), and before the issuance did not exceed $50,000,000;

(b) The aggregate gross assets of the corporation immediately after the issuance, determined by taking into account amounts received in the issuance, do not exceed $50,000,000, where “aggregate gross assets” mean the amount of cash and the aggregate adjusted basis of other property held by the corporation, but the adjusted basis of any property contributed to the corporation,or other property with a basis determined in whole or in part by reference to the adjusted basis of property so contributed, shall be determined as if the basis of the property contributed to the corporation immediately after the contribution was equal to its fair market value as of the time of the contribution; and

(d) For the purposes of this subsection, all corporations which are members of the same parent-subsidiary controlled group shall be treated as one corporation for purposes of this subsection, where “parent-subsidiary controlled group” means any controlled group of corporations as defined in section 1563(a)(1) of the Internal Revenue Code (26 U.S.C. s.1563(a)(1)), except that percentages of ownership and value that control shall exist in situations involving at least 50 percent of ownership and value as otherwise provided involving at least 80 percent required by section 1563(a)(1) (26 U.S.C. s.1563(a)(1)), and section 1563(a)(4) of the Internal Revenue Code (26 U.S.C. s.1563(a)(4)) shall not apply.

d. (1) The active business requirements of this subsection shall be met by a corporation for any period if during that period:

(a) at least 80 percent of the assets of the corporation, by value, are used by the corporation in the active conduct of one or more qualified trades or businesses; and

(b) the corporation is a domestic corporation, but not including any of the following: (i) a domestic international sales corporation (DISC) or former DISC; (ii) a regulated investment company, real estate investment trust (REIT), or real estate mortgage investment conduit (REMIC); or (iii) a cooperative.

(2) Assets used in the following activities of a corporation in connection with any future qualified trade or business, shall be treated as used in the active conduct of a qualified trade or business, whether or not a corporation has any gross income from those activities at the time of a determination pursuant to this paragraph, including:

(a) startup activities described in section 195(c)(1)(A) of the Internal Revenue Code (26 U.S.C. s.195(c)(1)(A));

(b) activities resulting in the payment or incurring of expenditures which may be treated as research and experimental expenditures under section 174 of the Internal Revenue Code (26 U.S.C. s.174); or

(c) Activities with respect to in-house research expenses described in section 41(b)(4) of the Internal Revenue Code (26 U.S.C. s.41(b)(4)).

(3) For purposes of this subsection, “qualified trade or business” means any trade or business other than any of the following:

(a) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of the trade or business is the reputation or skill of one or more of its employees;

(b) any banking, insurance, financing, leasing, investing, or similar business;

(d) any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A of the Internal Revenue Code (26 U.S.C. s.613 or s.613A); or

(e) any business of operating a hotel, motel, restaurant, or similar business.

(4) (a) For purposes of this subsection, stock and debt in any subsidiary corporation shall be disregarded and the parent corporation shall be deemed to own its ratable share of the subsidiary’s assets, and to conduct its ratable share of the subsidiary’s activities.

(b) A corporation shall be treated as failing to meet the requirements of paragraph (1) of this subsection for any period during which more than 10 percent of the value of its assets,in excess of liabilities, consists of stock or securities in other corporations which are not subsidiaries of the corporation,other than assets described in paragraph (5) of this subsection.

(c) For purposes of this paragraph, a corporation shall be considered a subsidiary if the parent owns more than 50 percent of the combined voting power of all classes of stock entitled to vote, or more than 50 percent in value of all outstanding stock, of the corporation.

(5) (a) For purposes of subparagraph (a) of paragraph (1) of this subsection, the following assets shall be treated as used in the active conduct of a qualified trade or business:

(i) assets that are held as a part of the reasonably required working capital needs of a qualified trade or business of the corporation; and

(ii) assets that are held for investment and are reasonably expected to be used within two years to finance research and experimentation in a qualified trade or business or increases in working capital needs of a qualified trade or business.

(b) For periods after the corporation has been in existence for at least two years, in no event may more than 50 percent of the assets of the corporation qualify as used in the active conduct of a qualified trade or business by reason of this paragraph.

(6) A corporation shall not be treated as meeting the requirements of paragraph (1) of this subsection for any period during which more than 10 percent of the total value of its assets consists of real property that is not used in the active conduct of a qualified trade or business. For purposes of this paragraph the ownership of, dealing in, or renting of, real property shall not be treated as the active conduct of a qualified trade or business.

(7) For purposes of paragraph (1) of this subsection, rights to computer software that produces active business computer software royalties,within the meaning of section 543(d)(1) of the Internal Revenue Code (26 U.S.C. s.543(d)(1)), shall be treated as an asset used in the active conduct of a trade or business.

e. If any stock in a corporation is acquired solely through the conversion of other stock in the corporation that is qualified small business stock in the hands of the taxpayer, the stock so acquired shall be treated as qualified small business stock in the hands of the taxpayer and the stock so acquired shall be treated as having been held during the period during which the converted stock was held.

f. (1) If any amount included in gross income by reason of holding an interest in a pass-through entity meets the requirements of paragraph (2) of this subsection, the following shall apply:

(a) the amount shall be treated as gain described in subsection a. of this section; and

(b) for purposes of applying subsection b. of this section, the amount shall be treated as gain from a disposition of stock in the corporation issuing the stock disposed of by the pass-through entity and the taxpayer’s proportionate share of the adjusted basis of the pass-through entity in the stock shall be taken into account.

(2) An amount shall meet the requirements of paragraph (1) of this subsection if:

(a) the amount is attributable to gain on the sale or exchange by the pass-through entity of stock that is qualified small business stock in the hands of the entity,determined by treating the entity as an individual, and that was held by that entity for more than five years; and

(b) the amount is includable in the gross income of the taxpayer by reason of the holding of an interest in the entity that was held by the taxpayer on the date on which the pass-through entity acquired the stock and at all times thereafter before the disposition of the stock by the pass-through entity.

(3) Notwithstanding any provision of law to the contrary, paragraph (1) of this subsection shall not apply to any amount to the extent the amount exceeds the amount to which that paragraph would have applied if the amount was determined by reference to the interest the taxpayer held in the pass-through entity on the date the qualified small business stock was acquired.

(4) For purposes of this subsection, “pass-through entity” means any of the following: a partnership; an S corporation; a regulated investment company; or a common trust fund.

g. For purposes of this section:

(1) In the case of a transfer described in paragraph (2) of this subsection, the transferee shall be treated as having both: acquired the stock in the same manner as the transferor; and held the stock during any continuous period immediately preceding the transfer during which it was held, or treated as held, by the transferor.

(2) A transfer, as described in this subsection, shall include any transfer made:

(a) by gift;

(b) at death; or

(c) froma partnership to a partner of stock with respect to which requirements similar to the requirements of subsection f. of this section are met at the time of the transfer,without regard to the five-year holding period requirement.

(3) Rules similar to the rules of section 1244(d)(2) of the Internal Revenue Code (26 U.S.C. s.1244(d)(2)) shall apply for purposes of this section.

(4) (a) In the case of a transaction described in section 351 of the Internal Revenue Code (26 U.S.C. s.351) or a reorganization described in section 368 of the Internal Revenue Code (26 U.S.C. s.368), if qualified small business stock is exchanged for other stock that would not qualify as qualified small business stock but for this paragraph, the other stock shall be treated as qualified small business stock acquired on the date on which the exchanged stock was acquired.

(b) This subsection shall apply to gain from the sale or exchange of stock treated as qualified small business stock by reason of subparagraph (a) of this paragraph only to the extent of the gain that would have been recognized at the time of the transfer described in subparagraph (a) of this paragraph if section 351 or 368 of the Internal Revenue Code (26 U.S.C. s.351 or s.368) had not applied at that time. The preceding sentence shall not apply if the stock that is treated as qualified small business stock by reason of subparagraph (a) of this paragraph is issued by a corporation that,as of the time of the transfer described in that subparagraph (a), is a qualified small business.

(c) For purposes of this paragraph, stock treated as qualified small business stock under subparagraph (a) of this paragraph shall be so treated for subsequent transactions or reorganizations, except that the limitation of subparagraph (b) of this paragraphshall be applied as of the time of the first transfer to which the limitation applied, determined after the application of the second sentence of subparagraph (b) of this paragraph.

(d) In the case of a transaction described in section 351 of the Internal Revenue Code (26 U.S.C. s.351), this paragraph shall apply only if immediately after the transaction the corporation issuing the stock owns directly or indirectly stock representing control,within the meaning of section 368(c) of the Internal Revenue Code (26 U.S.C. s.368(c)), of the corporation whose stock was exchanged.

h. For purposes of this section:

(1) In the case in which the taxpayer transfers property,other than money or stock, to a corporation in exchange for stock in the corporation, the stock shall be treated as having been acquired by the taxpayer on the date of the exchange and the basis of the stock in the hands of the taxpayer shall in no event be less than the fair market value of the property exchanged.

(2) If the adjusted basis of any qualified small business stock is adjusted by reason of any contribution to capital after the date on which the stock was originally issued, in determining the amount of the adjustment by reason of the contribution, the basis of the contributed property shall in no event be treated as less than its fair market value on the date of the contribution.

i. (1) If the taxpayer has an offsetting short position with respect to any qualified small business stock, subsection a. of this section shall not apply to any gain from the sale or exchange of the stock unless the stock was held by the taxpayer for more than five years as of the first day on which there was such a short position and the taxpayer elects to recognize gain as if the stock was sold on that first day for its fair market value.

(2) For purposes of paragraph (1) of this subsection, the taxpayer shall be treated as having an offsetting short position with respect to any qualified small business stock if any of the following apply:

(a) the taxpayer has made a short sale of substantially identical property;

(b) the taxpayer has acquired an option to sell substantially identical property at a fixed price; or

(c) to the extent provided in regulations, the taxpayer has entered into any other transaction that substantially reduces the risk of loss from holding the qualified small business stock. For purposes of the preceding sentence, any reference to the taxpayer shall be treated as including a reference to any person who is related,within the meaning of section 267(b) or 707(b) of the Internal Revenue Code (26 U.S.C. s.267(b) or s.707(b)), to the taxpayer.

j. A corporation that issues qualified small business stock agrees to submit reports to the Director of the Division of Taxation in the Department of the Treasury and to its shareholders as the director may require to carry out the purposes of this section.

2. The Director of the Division of Taxation in the Department of the Treasury shall prescribe regulations pursuant to the provision of the "Administrative Procedure Act," P.L.1968, c.410 (C.52:14B-1 et seq.) as may be appropriate to carry out the purposes of this act, including any regulations that may conform to those regulations promulgated by the Secretary of the Treasury under section 1202(k) of the Internal Revenue Code (26 U.S.C. s.1202(k)) that shall apply to the extent that those regulations do not conflict with this act, and such further regulation that shall include but be not limited to regulations to prevent the avoidance of the purposes of this act through splitups, shell corporations, partnerships, or otherwise.

3. This act shall take effect immediately and shall apply to taxable years beginning on or after the date of enactment.

STATEMENT

This bill allows a taxpayer to claim a deduction from New Jersey gross income for the capital gains earned from the sale or exchange of qualified small business stock (QSBS) held for more than five years. The maximum deduction allowable under the bill depends on the percentage of the qualified small business’ payroll, as measured by total dollar value, which is attributable to employment located within the State.

Specifically, if a taxpayer has capital gains for the taxable year from one or more dispositions of QSBS, the taxpayer would be allowed to claim a deduction, as follows: (1) if the percentage of the qualified small business’s payroll attributable to in-State employees is at least 80 percent, the maximum allowable deduction would be the greater of $10 million or 10 times the aggregate adjusted basis of the QSBS; and (2) if the percentage of the qualified small business’s payroll attributable to in-State employees is less than 80 percent, the maximum allowable deduction would be the greater of $8 million or 8 times the aggregate adjusted basis of the QSBS. However, these maximum allowable deduction amounts would be reduced by the aggregate amount of eligible gain claimed by the taxpayer for any prior taxable year and attributable to dispositions of stock issued by the corporation.

The maximum deduction of $10 million or 10 times the aggregate adjusted basis of QSBS is modeled on the federal capital gains exclusion allowed under section 1202 of the federal Internal Revenue Code.

Under the bill, a QSBS is generally defined to include any stock that is originally issued by a C corporation on or after January 1, 2015, provided the corporation qualifies as a qualified small business as of the date of issuance, and the stock was acquired by the taxpayer at its original issue, not a secondary market. The bill also requires the QSBS to have been acquired in exchange for money or property, or as compensation for services provided to the corporation.

For an individual taxpayer to qualify for the special capital gains treatment under the bill, the taxpayer is required to have held the QSBS for at least five years. Specifically, the stock is required to be in a qualified small business that is a domestic C corporation, and remains a C corporation during substantially all of the time the individual holds the stock, and which meets all of the following criteria: (1) the aggregate gross assets of the corporation do not exceed $50 million, both at all times after the effective date of the bill and before the issuance of the stock; (2) the aggregate gross assets of the corporation do not exceed $50 million as of the date the stock was issued and immediately thereafter; and (3) the corporation has fewer than 225 employees.

Additionally, during substantially all of the time the stock is held, at least 80 percent of the value of the corporation’s assets is required to be used in the active conduct of one or more qualified businesses. As under section 1202 of the federal Internal Revenue Code, the bill provides that a gross income tax deduction may not be claimed for a capital gain realized from the sale or exchange of a QSBS in a business that is: a service business in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services; a banking, insurance, financing, leasing, investing, or similar business; a farming business; a business of operating a hotel, motel, restaurant, or similar business.

If the individual taxpayer holds qualifying stock for at least five years, then the taxpayer would be able to exclude the capital gains made on the disposition of the stock, and thus pay no gross income on the capital gains. The special exclusion of capital gains for qualified stock that is held by “pass through entities,” including a partnership, an “S” corporation, a regulated investment company, or a common trust fund, that otherwise meet the requirements of this bill, is available to the individual gross income taxpayers who hold interests in those pass-through entities.