Today, the New Jersey Tax Court published its opinion in Xylem Dewatering Solutions, Inc. v. Director, Division of Taxation.1 The issue was whether the gain from a deemed asset sale under I.R.C. § 338(h)(10) recognized by a New Jersey-based S corporation was nonoperational (nonbusiness) income and thus 100% allocable to New Jersey, rather than subject to apportionment.2 Applying precedent developed under New Jersey's corporation business (income) tax,3 the court ruled that the deemed asset sale and liquidation resulted in nonbusiness income, and that New Jersey had the right to tax 100% of the gain.

The decision is a warning for New Jersey-based taxpayers: the court concluded that the Division of Taxation (not just taxpayers) can take advantage of nonbusiness income principles. But the decision is also relevant for out-of-state taxpayers.

Opportunity for Out-of-State Taxpayers: No NJ Tax on Liquidations

In ruling in favor of the Division of Taxation, the court stated that there "is no constitutional requirement" that income from an asset sale and complete liquidation be apportioned. According to the court, such income can be allocated 100% to the domiciliary state. Presumably, the court must have thought that the gain was not merely nonbusiness income, but also nonunitary with the taxpayer's regular trade or business. This follows from U.S. Supreme Court case law and the U.S. Constitution, which "precludes one state from characterizing as 'nonbusiness' income, and taxing on an unapportioned basis, income that is taxable in other states on an apportioned basis."4 Based on this principle, New Jersey would have been able to tax 100% of the taxpayer's gain in Xylem only if such gain were nonunitary with the S corporation's regular trade or business and, thus, nontaxable by any other state.

The Xylem decision provides a potential opportunity for out-of-state taxpayers that dispose of their assets pursuant to a complete liquidation. New Jersey narrowed its nonbusiness income definition in 2014: gain from the sale of property is now subject to apportionment as long as "the acquisition, management, or disposition" of the property constitutes an integral part of the taxpayer's regular trade or business.5 Beginning in 2014, therefore, it has been difficult for a taxpayer to claim nonbusiness income treatment on the sale of assets that were previously used in the taxpayer's business operations. But under Xylem, a taxpayer doesn't need to rely on the statutory definition of nonbusiness income to exclude liquidation gains from its apportionable tax base. In effect, the court has established a bright-line test that the gain from an actual or deemed sale of assets, followed by a complete liquidation, is nonunitary and, thus, not subject to apportionment—regardless of whether the gain constitutes nonbusiness income under the statute.

Accordingly, out-of-state taxpayers can take the position that any gains related to a complete liquidation must be excluded from their New Jersey tax base.

Reed Smith's state and local tax practice has 14 lawyers licensed to practice in New Jersey. Our team also includes accountants and paralegals to handle New Jersey tax matters of all types, from audit defense and appeals, to contingent-fee refund reviews. Unlike typical consulting firms, Reed Smith's team can handle your matter at all stages—including not only audit and administrative appeals, but also settlement negotiations at Tax Court and, if necessary, litigation.


  1. Docket Nos. 011704–2015, 000056–2016, 000057–2017 (N.J. Tax 2017).
  2. New Jersey designates nonbusiness income as "nonoperational income," but the statute is largely derived from the Uniform Division of Income for Tax Purposes Act. See N.J.S.A. 54:10A–6.1.
  3. See, e.g., McKesson Water Products Company v. Director, Div. of Taxation 23 N.J. Tax 449 (Tax 2007), aff'd, 408 N.J. Super. 213 (N.J. Super. Ct. App. Div. 2009), cert. denied, 200 N.J. 506 (N.J. 2009).
  4. Walter Hellerstein, The Constitutional Dimension of the 'Business'/'Nonbusiness' Income Distinction, State Tax Notes 91–10070 (Dec. 1, 1991).
  5. N.J.S.A. 54:10A–6.1 (italics added), amended by P.L. 2014, c. 13, § 1 (effective June 30, 2014).

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