New Jersey Tax Court Addresses State Income Tax Treatment of Taxes Paid to Other States

Two New Jersey Tax Court cases from the second half of 2014 highlight the considerable variation among the states in the treatment of taxes paid to other states.

For purposes of determining corporate or individual income tax liability, state tax laws address the treatment of taxes paid by a taxpayer to other states in two main ways. First, states typically require corporate and individual taxpayers to add back to federal taxable income (to the extent deducted for federal income tax purposes) income taxes paid to other states. For example, for Georgia corporate income tax purposes, a corporation must add back “any taxes on, or measured by, net income or net profits paid or accrued within the taxable year imposed . . . by any state except the State of Georgia . . . to the extent deducted in determining federal taxable income.” [1] For individual taxpayers, Georgia law requires that taxpayers add back to taxable income “any income taxes imposed by any jurisdiction except the state of Georgia to the extent deducted in determining federal taxable income.” [2] Second, in order to minimize the impact of double taxation for individuals who earn income outside their states of residence, states permit individual resident taxpayers a credit for taxes paid to other states, typically limited to the lesser of the amount of tax actually paid to the other state or the amount of tax that would have been levied by the resident state on the income subject to tax in the other state. [3] However, as is often the case with state taxes, there is considerable variation among the states in the treatment of taxes paid to other states, and two New Jersey Tax Court (the “Tax Court”) cases from the second half of 2014 highlight this point.

The first case addresses which taxes are required to be added back under New Jersey’s Corporation Business Tax (“CBT”). [4] The taxpayer, a distributor and seller of electricity, was based in Pennsylvania, and did business and paid taxes in multiple states, including Pennsylvania and New Jersey. The CBT requires that taxpayers add back taxes paid to any state (including New Jersey), when such tax is “on or measured by profits or income, or business presence or business activity.” [5] In calculating its CBT liability, the taxpayer did not add-back the deductions for certain Pennsylvania taxes, including the Pennsylvania Capital Stock Tax (“CST”). The New Jersey Division of Taxation (the “Division”) argued that the CST should have been added back for CBT purposes. The CST is levied upon capital stock value, which is computed as a function of both a five-year average book net income as well as current-year book net worth. Ultimately, the Tax Court determined that the CST is a property tax, and that the taxpayer was not required to add-back this tax when calculating its CBT liability.

The second case provides guidance on the application of New Jersey’s income tax credit for taxes paid to other states with respect to an individual resident shareholder of an S corporation that operates in multiple states. [6] The taxpayer was the sole shareholder of a New Jersey S corporation that operates in both New York and New Jersey. Using New York’s single sales factor apportionment rules, the S corporation apportioned 80 percent of its income to New York on its 2009 New York S-Corporation Franchise Tax Return. The taxpayer then filed her personal income tax returns in both New York and New Jersey for the income passed through to her as the sole shareholder. She paid $66,587 to New York (based on the 80 percent apportionment), and sought a credit of $66,587 against her New Jersey income taxes. However, the Division denied a portion of the credit based on a New Jersey law that limits the amount of credit in the case of a resident shareholder of an S corporation. Specifically, the statute provides that “No credit shall be allowed against the tax otherwise due . . . for the amount of any income tax . . . imposed for the taxable year on S corporation income allocated to this State.” [7] “S corporation income allocated to this State” is defined by reference to the New Jersey allocation statutes. [8]

Based on the statute, the Tax Court held that instead of using New York’s single sales factor apportionment formula, the shareholder was required to use New Jersey’s apportionment rules when calculating the credit for taxes paid to New York. Under New Jersey’s formula (utilizing a property, payroll, and double-weighted sales factors) approximately 39 percent of the S corporation’s income would have been allocated to New Jersey. Therefore, the shareholder’s credit was limited to approximately 61 percent of the S corporation’s income, resulting in her credit being reduced by about 25 percent.

These two cases emphasize the importance of understanding the subtle, yet potentially significant, distinctions among state tax rules. For example, while all states provide a credit to resident individuals for taxes paid to other states, the computation and limitations may differ. New Jersey is not the only state to take this position. Illinois statutes and regulations provide for a similar credit limitation, except that the limitation applies to all resident individual taxpayers, not just those that are shareholders of S corporations. [9] In addition, as more states enact entity taxes that are not based on net income, it becomes necessary to pay close attention to state add-back rules for taxes to make sure that a taxpayer is not unnecessarily adding back taxes not required to be added back. HA&W’s SALT group can advise you on these issues in order to minimize your tax liability or to avoid an unexpected assessment in the future.

Contact Jeff Glickman, partner-in-charge of HA&W’s State and Local Tax practice, at jeff.glickman@aprio.com for more information.

[1] Ga. Code Ann. § 48-7-21(b)(2).
[2] Ga. Code Ann. § 48-7-27(b)(3).
[3] Georgia’s credit provision allows a credit to taxes paid to another state that levies a tax on “net income.” Ga. Code Ann. § 48-7-27(b)(3). It is worth noting the difference in terminology between these three Georgia statutes – the corporate add-back provision refers to tax on or measured by “net income or net profits,” the individual add-back provision refers solely to “income taxes,” and the resident individual tax credit provision requires that the other state’s tax be levied upon “net income.”
[4] PPL Electric Utilities Corp. v. Director, Division of Taxation, 2014 WL 5018891, N.J. Tax Ct., 10/02/2014.
[5] N.J. Rev. Stat. § 54:10A-4(k)(2)(C).
[6] Criticare, Inc. and Marina Shakour Haber v. Director, Division of Taxation, 2014 WL 3407244, N.J. Tax Ct., 07/08/2014.
[7] N.J. Rev. Stat. § 54A:4-1(c).
[8] N.J. Rev. Stat. § 54A:5-10.
[9] 35 ILCS §5/601(b)(3); 86 Ill. Admin. Code §100.2197(e). The regulation was amended in 2015 to reflect that statutory changes that were applicable to tax years ending on or after Dec. 31, 2009.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding this matter.

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