/ 3 min read / Reed Smith In-depth

New Jersey Corporation Business Tax: Third Time’s a Charm?

Authors

Matthew L. Setzer, Chandler N. Scanlon, David J. Gutowski
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.
  • Time period to adjust net operating losses. In R.O.P. Aviation, Inc. v. Director, Division of Taxation,15 the New Jersey Tax Court set aside the Division’s longstanding policy and held that a taxpayer’s NOL carryovers could not be adjusted to the extent they were generated in years that are beyond the four-year limitations period for assessment. A5323 would reverse this rule for privilege periods ending July 31, 2022 or later by allowing the Division (as well as the taxpayer itself) to adjust NOLs for up to 10 years after they are initially reported on the taxpayer’s CBT-100 return.
  • World-wide group election. A5323 would clarify that if a taxpayer elects to compute its tax on a world-wide basis, then the combined group “shall include all of the income and attributes of [all of its] members . . . without regard to any exemption or exclusion from federal taxable income under the terms of a tax treaty.16
  • NOL limitation. Under A5323, New Jersey would limit a taxpayer’s annual NOL deduction to 80% of taxable income (mirroring the federal NOL deduction limitation).17
  • NOL-Dividend Ordering Rule. Historically, taxpayers were required to deduct NOL carryovers before applying the dividends received deduction. In effect, therefore, dividends absorbed NOLs. A5323 would change this ordering rule. Specifically, A5323 states that a combined group shall deduct the dividends received deduction from entire net income “after the State modifications that increase federal entire net income but before the other State modifications that reduce entire net income.”18

    Although this represents a welcome policy shift, the new rule would apply only for privilege periods ending July 31, 2023 or later. If your company lost NOL carryovers on account of receiving dividends in prior periods, you may be able to resurrect those NOLs and either claim a refund or adjust your carryover amount. In particular, taxpayers may be entitled to relief based on New Jersey’s equitable apportionment provisions or by taking advantage of New Jersey’s taxpayer-friendly nonunitary business case law.
  • Dividends received deduction. As part of the adoption of combined reporting, the Legislature reduced the dividends received deduction for 80%-or-greater owned subsidiaries from 100% to 95%.19 A5323 would increase the dividends received deduction back to 100%, beginning with the 2023 privilege period.20 The dividends received deduction is subject to a 5% addback.
  • GILTI treated as a dividend. Under A5323, GILTI would be “considered a dividend.”21 As a result, GILTI attributable to 80%-or-more owned CFCs would qualify for a full dividends received deduction. This is subject to the same 5% addback mentioned in the prior bullet.
  • Interest deduction. For purposes of the I.R.C. § 163(j) interest limitation, A5323 would treat the members included on a New Jersey combined return as though they had filed a federal consolidated return.22 This mirrors the Division’s informal policy and guidance as set forth in Technical Bulletin 87.
  • Repeal of interest and intangible addbacks. Under A5323, the current statutory provisions concerning the addback of related party interest and intangible expenses would be repealed.23 Because transactions between members of a combined group are generally eliminated, this change should have little or no effect on payments between domestic affiliates.24 But if you added back interest or intangible expenses prior to combination, you should consider filing a refund claim. Despite the somewhat narrow exceptions set forth in the Division’s return instructions, taxpayers are often able to qualify for exception. In addition, there is pending litigation challenging the constitutionality of the Division’s interest and intangible addback regulations. (For further information, see our prior Alert.)

Next Steps

We expect A5323 to pass the Legislature, and the Governor to sign the bill into law. If you are interested in how A5323 could impact your company, email one of the authors of this alert, or contact the Reed Smith attorney with whom you generally work.

  1. A. 5323, 220th Leg., Reg. Sess. (N.J. 2023) (hereinafter cited as “A5323”).
  2. N.J.S.A. 54:10A–4(v)(2) (providing for allocated net operating loss).
  3. N.J.S.A. 54:10A–4(u) (providing for calculation of prior net operating loss conversion carryover).
  4. See generally N.J.S.A. 54:10A–4.5 (providing exceptions to sharing of PNOL).
  5. N.J.S.A. 54:10A–4.6(g)(1).
  6. A5323, Sec. 2 (amending N.J.S.A. 54:10A–4.6(g)(1)).
  7. See 54 N.J.R. 865(a), Summary (proposed May 16, 2022) (noting that New Jersey follows the “Joyce Method”).
  8. A5323, Sec. 3 (adding subsection (e) to N.J.S.A. 54:10A–4.7).
  9. See New Jersey Division of Taxation, Included and Excluded Business Entities in a Combined Group and the Minimum Tax of a Taxpayer that is a Member of a Combined Group, TB-86(R) (revised April 20, 2022).
  10. See N.J.S.A. 54:10A–4(k)(16) (defining deferred tax impact deduction).
  11. A5323, Sec. 3 (amending N.J.S.A. 54:10A–4(k)(16)).
  12. A5323, Sec. 8 (adding subsection (d) to N.J.S.A. 54:10A–10).
  13. A5323, Sec. 8 (adding subsection (e) to N.J.S.A. 54:10A–10).
  14. See generally Bank of Am. Consumer Card Holdings v. Division of Taxation, 29 N.J. Tax 427, 471 (N.J. Tax Ct. 2016).
  15. 32 N.J. Tax 346 (N.J. Tax Ct. 2021).
  16. A5323, Sec. 1 (adding subsection (kk) to N.J.S.A. 54:10A-4(k).
  17. A5323, Sec. 1 (amending N.J.S.A. 54:10A–4(w)).
  18. A5323, Sec. 1 (adding subsection (F) to N.J.S.A. 54:10A–4(k)(5)).
  19. See N.J.S.A. 54:10A–4(k)(5) (defining dividends received deduction).
  20. A5323, Sec. 1 (adding subsection (iv) to N.J.S.A. 54:10A–4(k)(5)(A)).
  21. A5323, Sec. 1 (adding subsection (G) to N.J.S.A. 54:10A–4(k)(5)).
  22. A5323, Sec. 1 (adding subsection (ii) to N.J.S.A. 54:10A–4(k)(2)(K)).
  23. A5323, Sec. 1 (repealing N.J.S.A. 54:10A–4(k)(2)(I)); see also A5323, Sec. 15 (repealing N.J.S.A. 54:10A–4.4).
  24. See generally N.J.S.A. 54:10A–4.6(e).

In-depth 2023-076

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