Aciu v. Director, Division of Taxation, No. 020999-2010; Tax Court; opinion by Menyuk, J.T.C.; decided and approved for publication October 9, 2012. DDS No. 35-5-7929 [17 pp.]
At issue is whether defendant, the director of the Division of Taxation, properly denied a refund of gross income taxes claimed on account of an exclusion of 50 percent of the capital gain on the sale of certain qualified small business stock. The exclusion is expressly permitted by federal tax law, namely, I.R.C. § 1202.
Plaintiff was a resident of New Jersey during all of calendar year 2008. She owned 16,970 shares of common stock in Vision Research Inc (VR). Her total tax basis in the shares was $4,456,760. In June 2008, plaintiff sold all of the VR shares to Ametek Inc. pursuant to a stock purchase agreement. The sales price was $17,236,114. During 2008, she received payments for the 16,970 VR shares totaling $15,850,968. The terms of the stock purchase agreement required the remainder of the sales price to be placed in escrow and retained for 36 months, after which it would be distributed.
Plaintiff and her tax advisers determined to amend her tax returns for 2008, to report the sale of 16,570 VR shares as an installment sale of “qualified small business stock.” The federal tax code allows a taxpayer to exclude 50 percent of the gain from the sale of qualified small business stock held for more than five years.
Plaintiff’s amended New Jersey return included a copy of the federal Schedule D that had been prepared for the amended federal return. The amended New Jersey return reported net gains from the disposition of property of $6,202,359, as compared with $11,776,851 on the original return. The amendment to the 2008 New Jersey gross income tax return resulted in a claimed $499,748 overpayment of 2008 New Jersey gross income taxes.
The Division of Taxation audited the amended New Jersey return and disallowed the 50 percent exclusion on the sale of the 16,570 VR shares that, for federal purposes, was qualified small business stock. It issued a notice of deficiency of $32,160 plus interest. Plaintiff timely protested the division’s audit determination, which was upheld by the director. Plaintiff filed a timely appeal with the Tax Court.
Held: The director correctly disallowed the exclusion of 50 percent of the gain on the sale of qualified small business stock in the calculation of net gains or income from the disposition of property where the New Jersey Gross Income Tax Act did not incorporate the exclusion permitted by I.R.C. § 1202.
The director does not question that plaintiff’s amended federal return appropriately excluded 50 percent of the gain from the sale of 16,570 VR shares pursuant to I.R.C. § 1202(a). The director maintains, however, that there is no provision in the New Jersey Gross Income Tax Act that provides for a similar exclusion.
Plaintiff, on the other hand, argues that N.J.S.A. 54A:5-1c specifically provides for the incorporation of federal tax principles and concepts in the calculation of net gains on the disposition of property and that the federal exclusion allowed by § 1202 should be applied in calculating the net gain for gross income tax purposes. Plaintiff further asserts that the director is bound by his instructions for filing Form NJ-1040, which direct the taxpayer to list at line 1, Schedule B, any New Jersey taxable transaction as reported on the federal Schedule D.
The court concludes that the act does not permit the construction of N.J.S.A. 54A:5-1c sought by plaintiff. Section 5-1c explicitly incorporates three federal tax concepts that are to be used in determining net gains from the disposition of property: (1) the method of accounting used for federal income tax purposes; (2) the use of the federal adjusted basis; and (3) the exclusion of gains to the extent federal rules require nonrecognition. The plain words of § 5-1c do not require the exclusion of half the gain on a sale of qualified small business stock. Contrary to plaintiff’s arguments, there is nothing in either § 5-1c or the cases construing that section that incorporates all federal tax concepts and principles. It was the intent of the Legislature in drafting the act to avoid including the loopholes and tax preferences contained in the federal tax code. I.R.C. § 1202 is exactly such a preference, in the form of an incentive for a particular type of investment.
Plaintiff further maintains that the directions for reporting net gains or income from the distribution of property contained in the instructions to the 2008 Form NJ-1040 constitute, in effect, the director’s interpretation of § 5-1c that incorporates federal tax principles and concepts, including the exclusion provided by I.R.C. § 1202. A complete reading of the director’s instructions to the 2008 Form NJ-1040 makes plain that the director has not construed § 5-1c to wholly incorporate federal tax law. The instructions clearly state what may be deducted in computing gain, and those items do not include the excludable gains provided by I.R.C. § 1202.
It is implicit in these instructions that the taxpayer may not carry over from Schedule D any federal tax preferences which have not been expressly provided for by the act.
The court concludes that the final determination of the director, rejecting the plaintiff’s exclusion of 50 percent of the gain on the sale of qualified small business stock, is correct and is, therefore, affirmed.
For plaintiff — James B. Evans Jr. (Kulzer & DiPadova). For defendant — Ramanjit K. Chawla (Jeffrey S. Chiesa, Attorney General).