The Garden State Bears Some Fruit

A recent decision handed down by the New Jersey Tax Court (Beljakovic v. Director, Division of Taxation) not only provides taxpayers with a potential refund opportunity, it highlights the length to which some state taxing authorities will go in defense of an irrational result.

The facts of the case are straightforward and undisputed. The taxpayers were residents of New Jersey and owned and operated a business through an S corporation (S Corp).  S Corp did not maintain any regular place of business outside of New Jersey, though it did derive income in other jurisdictions including New York State and City.

For the 2006 tax year, S Corp filed an S Corporation return in New York State and paid a minimum tax.  Since New York City does not recognize S corporations, but rather, taxes them as C corporations, S Corp filed and paid tax as a general business corporation.  As a result of having New York sourced income via S Corp, the taxpayers filed a New York non-resident income tax return and paid tax (approximately $34,000) on the New York sourced income.

In New Jersey, S Corp filed its S corporation return and, as was statutorily required, sourced 100% of its income to the State notwithstanding the fact that S Corp had New York sourced income.  Prior to a change in law effective July 1, 2010, New Jersey did not permit corporations that did not maintain a "regular place of business" outside the state to apportion any of its income outside the state.  In this case, S Corp did not have a regular place of business outside of New Jersey.

In computing their 2006 New Jersey Gross Income Tax (GIT), the taxpayers reported a credit against their GIT for the non-resident income taxes paid to New York.  Had the taxpayers not taken the credit, they would effectively have been taxed twice on the same income - once in New York then again in New Jersey.

Upon audit, the Division of Taxation (Division) disallowed the taxpayers' utilization of the credit for the taxes paid to New York.  The Division's primary argument stemmed from a hyper-technical reading and application of the regular place of business rule and another provision of law under the GIT that disallows a credit for taxes paid where, as here, income from a S corporation is sourced to New Jersey.  At the heart of it, the Division's argument attempted to elevate form over substance.

The regular place of business rule under the Corporation Business Tax (CBT) created the fiction that a business without physical presence outside New Jersey would not have sourced income from other states and therefore, must apportion 100% to New Jersey. Obviously, as demonstrated in this case, it ignored the reality that a taxpayer could have nexus outside New Jersey (albeit not stemming from a permanent physical perspective), and thus, sourced income from other states.

Fortunately, the Tax Court saw through the absurdity presented by the Division and essentially ruled that the legislature could not have intended such a result.  The Tax Court recognized a well-established and basic tenet of taxation is to avoid double taxation.  By elevating substance over form, the Tax Court ruled in favor of the taxpayers, and in so doing, restored hope for a fair and equitable taxing regime to New Jersey.

As a result of the case there exists a refund opportunity for New Jersey taxpayers that followed the statutory construct in place prior to July 1, 2010, and did not report a credit for taxes paid to other jurisdictions as result of receiving income from a New Jersey based S corporation.  As New Jersey imposes a three year statute of limitations for refunds of GIT, refunds may be available dating back to the 2008 tax year depending on when the GIT return was filed.