QSBS Court Ruling: Aciu v. Director-Do All States Conform with I.R.C §1202 under Federal Tax Law?

Tax Court of New Jersey, No. 020999-2010, October 9, 2012

KEY QSBS TAKEAWAY(S): In Aciu v. Director, the taxpayer failed to prove that the language in N.J.S.A. 54A:5–1(c) followed the federal tax exemption on the sale of capital gains under I.R.C. § 1202. Also, the taxpayer failed to prove that the omission of “net gains on the sale of QSBS” language on NJ-1040 form meant that the federal income tax law should be adopted; therefore, allowing a 50% exclusion on the capital gain of sold Vision Research, Inc. shares with a reported amounted of $11,776,851 on both federal and New Jersey Income Tax return forms. The court concluded that the New Jersey Gross Income Tax Act created by Legislation in 1976 was meant to exclude the taxpayer incentive, such as the one found in the federal tax code I.R.C. § 1202.

QUESTION PRESENTED: Can every taxpayer in the United States claim a tax exemption under I.R.C. § 1202 from the capital gains of sold qualified small business stock (QSBS)? If language is omitted on a state’s Income Tax Return form, does that mean federal tax law should be adopted?

RULE(s):

(1) New Jersey tax law did not incorporate federal exclusion for small business stock sales. See I.R.C. § 1202; N.J.S.A. 54A:5–1(c). (2) It was the intent of the Legislature in drafting the New Jersey Gross Income Tax Act to avoid including the incentives and tax preferences contained in the federal tax code. N.J.S.A. 54A:1–1 et seq.. (3) Only erroneous advice furnished to a taxpayer in writing will have any effect on a taxpayer’s liability, and that effect is a waiver of penalty and interest, and not of the tax actually due. N.J.S.A. 54:49–11(a). See Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, (2012).

MAIN QSBS ISSUES ADDRESSED:

(1) Conformity of federal tax law, specifically I.R.C. § 1202, in the state of New Jersey; (2) Does the omission of language in New Jersey tax forms mean the adoption of federal tax law.

CIRCUMSTANCES:

The taxpayer sold 16,970 shares, from Vision Research, Inc., of qualified small business stock to Ametek, Inc. in June 2008. The reported amount of long-term capital gain was $11,776,851. The taxpayer and their accountant interpreted the NJ-1040 tax form language to follow the federal tax code I.R.C. § 1202 provision; however, the New Jersey Legislation purposefully drafted the New Jersey Gross Income Tax Act of 1976 to avoid the federal tax incentives, such as the one found under I.R.C. § 1202.

FACTS:

Plaintiff/Taxpayer was a resident of New Jersey during the 2008 tax year at issue. The taxpayer owned 16,970 shares of common stock in a qualified business (see I.R.C. §1202(d)) named Vision Research, Inc. that totaled $4,456,760 for the shares. In June 2008, the taxpayer sold all 16,970 shares to Ametek, Inc. during a stock purchase agreement totaling $15,850,968 after post-closing adjustments. There was an escrow agreement where the remaining sale was to be held for 36 months after the initial purchase agreement. 

The taxpayer hired a public accountant to file both, federal and New Jersey, income tax returns for the year of 2008. The accountant and taxpayer reported $11,776,851 on the federal tax form as long-term capital gain from the sold Vision Research, Inc. shares. On the New Jersey tax form the accountant and taxpayer reported the $11,776,851 as net gains or income from disposition of property. Subsequently, they both amended the income tax forms to report the sale of the shares as Qualified Small Business Stock; which would exclude 50% of the gain from the sale of QSBS held more than 5 years. See I.R.C. § 1202(a)(1). The Director does not contend that Vision Research, Inc. was a qualified business under I.R.C. §1202(d) and the stock was QSBS under I.R.C. § 1202(c). Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 534-35 (2012).

The amended return reported 400 of the shares did not qualify for § 1202 exclusion. Therefore, schedule D of the federal form reported capital gain of $6,202,359 rather than the $11,776,851. The accountant stated in court that he contacted the Director’s office and confirmed that QSBS should be reported on the amended report, relying on the instructions from Form NJ-1040. id. at 535. (said instructions are listed further in the brief).

The Division of Taxation of New Jersey audited the amended form, rejecting the 50% tax exclusion from the sale of 16,570 Vision Research, Inc. shares. The taxpayer received a notice of deficiency totaling $32,160 plus interest on October 21, 2009. id. at 536. A protest was held and the protest was upheld in the Directors favor as of September 28, 2010. id. The taxpayer successfully appealed to this case in the New Jersey Tax Court.

Director argues that:

“…there is no provision in the New Jersey Gross Income Tax Act, N.J.S.A. 54A:1–1 to 54A:9–25.1 (the “Act”), that provides for a similar exclusion.”

(quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 535 (2012))

Plaintiff 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.”

(quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 536-37 (2012))

ANALYSIS:

The court analyzed the statutory construction under the ruling in  Koch v. Director, Division of Taxation, 157 N.J. 1, 7, 722 A.2d 918 (1999). The issue in that case surrounded the calculation of net gain under § 5-1(c). The court stated, “If the statute ‘is clear and unambiguous on its face and admits of only one interpretation, [courts should] delve no deeper than the act’s literal terms to divine the Legislature’s intent.’” The majority of courts favor the Director’s translation of tax statutes; however, courts do not absolutely defer to the Director’s interpretation. 

N.J.S.A. 54A:5–1c (“Section 5–1c”) provides, in pertinent part:

“New Jersey gross income shall consist of the following categories of income: (c.) Net gains or income from disposition of property. Net gains or net income, less net losses, derived from the sale, exchange or other disposition of property, including real or personal, whether tangible or intangible as determined in accordance with the method of accounting allowed for federal income tax purposes. For the purpose of determining gain or loss, the basis of property shall be the adjusted basis used for federal income tax purposes, except as expressly provided for under this act….The term “net gains or net income” shall not include gains or income from transactions to the extent to which nonrecognition is allowed for federal income tax purposes.

(quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 538 (2012)); see N.J.S.A. 54A:5–1c.

“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. Koch v. Director, Div. of Taxation, supra, 157 N.J. at 6–7, 722 A.2d 918; Walsh v. Div. of Taxation, 10 N.J. Tax 447, 459 (Tax 1989), aff’d per curiam, 240 N.J. Super. 42, 572 A.2d 222 (App. Div. 1990).”

(quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 538 (2012))

At court, the taxpayer could not identify what federal tax concept, out of the three, from Section 5-1(c) related to the tax exclusion on capital gains. Contrary, the taxpayer relied on New Jersey case law rather than the Section 5-1(c) provisions. The taxpayer argued “…that because the transaction in issue—the sale of 16,570 VR shares—is clearly a sale of property to which Section 5–1c is applicable, the calculation of the gain is governed by incorporated federal tax rules, namely I.R.C. § 1202.” (quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 539 (2012)). The taxpayer asserts, based off of these cases*, that the court incorporated a gatekeepr test; stating “if a transaction is not a “sale, exchange or other disposition of property” described by Section 5–1(c), then Section 5–1(c) and its incorporated federal income tax concepts are inapplicable.” (quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 539 (2012))

*King v. Director, Div. of Taxation, 22 N.J. Tax 627, 632 (App.Div.2005); Walsh v. Director, Div. of Taxation, 15 N.J. Tax 180, 185–86 (App. Div. 1995); Vinnik v. Director, Div. of Taxation, 12 N.J. Tax 450, 454 (Tax 1992).

The Taxpayer contended “that if the transaction in issue is a disposition of property to which Section 5–1c is applicable, then federal tax concepts are incorporated in their entirety”. (quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 539 (2012)). However, the court concluded in Smith v. Director, Division of Taxation, 108 N.J. 19, 33, 527 A.2d 843 (1987), that the New Jersey Gross Income Tax Act and the federal tax code are contrasting statutes. The reasoning is because the New Jersey Legislature disagreed with the federal income tax method of an exclusion on gross income tax in order to incentivize taxpayers. id. at 32, 527 A.2d at 843. The taxpayer also cited Guzzardi v. Director, Division of Taxation, 15 N.J. Tax 395 (Tax 1995), aff’d per curiam, 16 N.J. Tax 374 (App. Div. 1996), stating that the court has construed Section 5-1(c) in a manner that seems to adopt federal tax law. However, the court in Guzzardi, repudiated the idea that the New Jersey Gross Income Tax Act incorporated federal tax law provisions with the taxation exemption on the sale of capital gains including capital loss “rollovers.” Aciu, 26 N.J. Tax at 544.

The instructions in form 1040 stating “[l]ist at Line 1, Schedule B any New Jersey taxable transaction(s) as reported on your Federal Schedule D, indicating the gain or loss for each transaction in column f.” state what exactly is deductible. id. at 545. The court concluded that the instructions do not include the excludible gains provided by I.R.C. § 1202. id. The instructions omitted any specific language pointing to the calculation of net gain on the sale of QSBS. Therefore, the taxpayer argues that the omission should be interpreted to be an adoption of all federal tax principles in conjunction with net income and gain. id. at 547. The taxpayer’s contention does not follow the two instances where the courts provided guidance: “(1) from Koch, supra, the use of a New Jersey rather than the federal basis in computing gain from the sale of a partnership interest (2) and from Guzzardi, supra, the Act’s lack of loss [rollover] provisions.” (quoting Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, 547 (2012)). Concluding, the instructions to NJ-1040 form are guided by the language from the New Jersey Gross Income Tax Act rather than federal tax law under I.R.C § 1202. Even if there was erroneous advice from the taxpayer’s accountant, the IRS will only waive the penalty and interest fee, not the tax actually due. See 4 N.J.S.A. 54:49–11(a).

COURT RULING:

The court decided in this case that:

  1. The court concluded that the Director was correct for rejecting the taxpayer’s exclusion of 50% of the gain on the sale of qualified small business stock.
  2. The court concluded that the New Jersey Gross Income Tax Act does not follow the language of N.J.S.A. 54A:5–1(c) sought by the taxpayer, which was the federal tax law under I.R.C. § 1202
  3. The court concluded that it was the intent of the Legislature when drafting the New Jersey Gross Income Tax Act to prevent taxpayer loopholes found in the federal tax code I.R.C. § 1202
  4. The court concluded that the instructions under the NJ-1040 form were clear and is correct for omitting net gain on QSBS language.

PROCEDURE: Tax Court of New Jersey, No. 020999-2010, October 9, 2012

CITATION: Aciu v. Dir., Div. of Tax’n, 26 N.J. Tax 532, (2012)

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