United States: New Jersey Corporation Business Tax Amendments Signed Into Law

On July 3, 2023, Governor Phil Murphy signed substantive tax legislation into law that amends the corporation business tax statute.¹ The legislation is a compromise between the Division of Taxation and the business community, and should be viewed as a win-win for both parties.² Our prior coverage is available on reedsmith.com. Here's what you should know about the legislation.

Summary of 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.³ Pre-apportioned loss carryovers had to be converted to post-apportioned carryovers (called prior net operating loss conversion carryovers or "PNOLs").⁴ But under the original combined reporting provisions,⁵ PNOLs could generally be used only by the taxpayer that created them.⁶ 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, the amendments allow members in a combined group to share their PNOLs with other members.⁷ 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 policy (pre-amendments) is that Joyce applies to combined groups that elect to file on water's-edge or worldwide basis.⁸ 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 the amendments, New Jersey shifts to the Finnigan apportionment method.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

Rather than a 10%-per-year deduction beginning in 2023, the amendments provide for a 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.

Time period to adjust net operating losses. In R.O.P. Aviation, Inc. v. Director, Division of Taxation,¹¹ 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. The amendments 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. The amendments 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.¹²

NOL limitation. The amendments limit a taxpayer's New Jersey annual NOL deduction to 80% of taxable income (mirroring the federal NOL deduction limitation).¹³

NOL-Dividend Ordering Rule. Historically, taxpayers were required to deduct NOL carryovers before applying the dividends received deduction. In effect, therefore, dividends absorbed NOLs. The amendments change this ordering rule. Specifically, the provisions state 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."¹⁴

Although this represents a welcome policy shift, the new rule applies 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%.¹⁵ The amendments increase the dividends received deduction back to 100%, beginning with the 2023 privilege period.¹⁶ The dividends received deduction is subject to a 5% addback.

GILTI treated as a dividend. Under the amendments, GILTI is "considered a dividend."¹⁷ 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 paragraph.

Interest deduction. For purposes of the I.R.C. § 163(j) interest limitation, the amendments treat the members included on a New Jersey combined return as though they had filed a federal consolidated return.¹⁸ This mirrors the Division's informal policy and guidance as set forth in Technical Bulletin 87.

Repeal of interest and intangible addbacks. The amendments repeal the statutory provisions concerning the addback of related party interest and intangible expenses.¹⁹ Because transactions between members of a combined group are generally eliminated, this change should have little or no effect on payments between domestic affiliates.²⁰ 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

Expect the Division to start working on regulations to implement the legislation. Moreover, expect to play a part in the regulatory process. What we have learned from the Division over the last several years is that the Division is willing to listen to the business community. And you should utilize the ability to work with the Division. If you have a particular fact pattern that is unique or may affect other taxpayers, reach out to the Division to determine if a solution is available.

Finally, if you are interested in how the legislation will impact your company, email one of the authors of this alert, or contact the Reed Smith attorney with whom you generally work.

Footnotes

1. A. 5323, 220th Leg., Reg. Sess. (N.J. 2023) (hereinafter cited as "A5323"). The companion bill is S3737. Both bills, on final passage from the Legislature, were identical.

2. For example, some provisions were removed from the final bill after discussions between the Division and the business community. Compare A5323, Sec. 8 (adding subsection (e) to N.J.S.A. 54:10A–10) (introduced March 20, 2023) with A5323, Sec. 8 (adding subsection (e) to N.J.S.A. 54:10A–10) (signed July 3, 2023).

3. N.J.S.A. 54:10A–4(v)(2) (providing for allocated net operating loss).

4. N.J.S.A. 54:10A–4(u) (providing for calculation of prior net operating loss conversion carryover).

5. See generally N.J.S.A. 54:10A–4.5 (providing exceptions to sharing of PNOL).

6. N.J.S.A. 54:10A–4.6(g)(1).

7. A5323, Sec. 2 (amending N.J.S.A. 54:10A–4.6(g)(1)) (signed into law on July 3, 2023).

8. See 54 N.J.R. 865(a), Summary (proposed May 16, 2022) (noting that New Jersey follows the "Joyce Method").

9. A5323, Sec. 3 (adding subsection (e) to N.J.S.A. 54:10A–4.7) (signed into law on July 3, 2023). This change, arguably, represents a return to the Division's original policy, which it had reversed after discussions last year with the taxpayer community. 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. 32 N.J. Tax 346 (N.J. Tax Ct. 2021).

12. A5323, Sec. 1 (adding subsection (kk) to N.J.S.A. 54:10A-4(k)) (signed into law on July 3, 2023).

13. A5323, Sec. 1 (amending N.J.S.A. 54:10A–4(w)) (signed into law on July 3, 2023).

14. A5323, Sec. 1 (adding subsection (F) to N.J.S.A. 54:10A–4(k)(5)) (signed into law on July 3, 2023).

15. See N.J.S.A. 54:10A–4(k)(5) (defining dividends received deduction).

16. A5323, Sec. 1 (adding subsection (iv) to N.J.S.A. 54:10A–4(k)(5)(A)) (signed into law on July 3, 2023).

17. A5323, Sec. 1 (adding subsection (G) to N.J.S.A. 54:10A–4(k)(5)) (signed into law on July 3, 2023).

18. A5323, Sec. 1 (adding subsection (ii) to N.J.S.A. 54:10A–4(k)(2)(K)) (signed into law on July 3, 2023).

19. A5323, Sec. 14 (repealing N.J.S.A. 54:10A–4.4) (signed into law on July 3, 2023)

20. See generally N.J.S.A. 54:10A–4.6(e).

This article is presented for informational purposes only and is not intended to constitute legal advice.