Reed Smith In-depth

On March 20, 2023, a bill (A5323) was introduced to amend the corporation business tax statute.1 The proposed legislation is expected to be adopted by early summer, which would be the third statutory amendment since New Jersey adopted combined reporting in 2018. The current bill contains not only technical corrections to New Jersey’s combined reporting provisions, but also a number of policy changes. Many (though not all) taxpayers could benefit from the amendments.

Summary of Proposed Statutory Changes

  • Sharing of prior net operating losses. With combined reporting, New Jersey shifted from a pre-apportioned to a post-apportioned net operating loss deduction starting with the 2019 tax year.2 Pre-apportioned loss carryovers had to be converted to post-apportioned carryovers (called prior net operating loss conversion carryovers or “PNOLs”3). But under the original combined reporting provisions,4 PNOLs could generally be used only by the taxpayer that created them.5 So, PNOLs could be trapped in entities that couldn’t use them because of low New Jersey apportionment. This was a particular problem for loss entities whose New Jersey apportionment decreased following the switch to single-factor market sourcing or because of the elimination of intercompany sales under combined reporting.

    By contrast, effective for the 2023 privilege period, A5323 would allow members in a combined group to share their PNOLs with other members.6 This represents a major policy shift and should prevent PNOLs from becoming trapped. Importantly, taxpayers with valuation allowances on their PNOLs may be able to adjust their deferred tax assets for financial statement purposes.
  • Shift from Joyce to Finnigan. The Division of Taxation’s current policy is that Joyce applies to combined groups that elect to file on water’s-edge or worldwide basis.7 So, the group’s sales-fraction numerator includes only New Jersey receipts earned by taxable members that have New Jersey nexus and are not protected by P.L. 86-272

    Under A5323, New Jersey would shift to the Finnigan apportionment method.8 This represents a return to the Division’s original policy, which it had reversed after discussions last year with the taxpayer community.9
  • Deferred tax impact deduction. To mitigate the impact of combined reporting on taxpayers’ financial statements, the original statute allowed an annual deduction to offset the change to taxpayers’ deferred tax assets and liabilities. The deduction would be taken over a ten-year period (10% per year), beginning with the 2023 privilege period.10

    Some states such as Massachusetts have sought to defer this type of deduction indefinitely and there was concern that New Jersey would do the same. But after extensive discussions with the business community, the deferred tax impact deduction has been retained in modified form.11 Rather than a 10%-per-year deduction beginning in 2023, A5323 provides for 1%-per-year deduction beginning in 2023 and then increases to a 5%-per-year deduction beginning in 2030 until the deduction amount has been fully utilized.
  • Director’s discretion. A5323 would provide the Director with broad discretion to combine or de-combine taxpayers, and to make adjustments to the income, loss, and apportionment of combined groups.12 Under the proposed legislation, the Director’s adjustments would be presumed correct. A taxpayer that disagrees with the Director’s adjustments would have the burden of proving that the Director’s adjustment is incorrect based on “cogent evidence that is definite, positive, and certain in quality and quantity . . . .”13

    In some ways, this new burden-of-proof standard mirrors existing New Jersey case law on discretionary adjustments.14 But there is doubt whether that judicial standard was intended to apply beyond context of property tax assessment or sales and use tax audits of cash businesses. Regardless, vesting the Director with such broad discretion could create taxpayer uncertainty and make New Jersey an outlier compared to other states.