New Jersey: NOLs from a Closed Tax Year Cannot be Adjusted When Applied to an Open Year

Listen to a brief overview of state tax developments this week, including New Jersey, or read full New Jersey development below.

Detailed New Jersey Development

In a decision approved for publication, the New Jersey Tax Court recently held that the Division of Taxation was not permitted to eliminate carried forward NOLs generated in closed tax years to a tax year under examination. The taxpayer, a corporation engaged in the business of aircraft leasing, reported NOLs on its 2007 to 2011 Corporation Business Tax (CBT) returns. Returns for these years were filed timely and were never audited. The Division later initiated an audit for the 2012 to 2015 tax years and adjusted the taxpayer’s returns in those open years by adjusting the transfer pricing related to aircraft leases between the taxpayer and related entities. It further took a position that the same transfer pricing principles should have been applied to the 2007-2011 returns, which eliminated NOLs in those years. The elimination of the carried forward NOLs resulted in assessments for the open tax years, which the taxpayer appealed.

The tax court held that permitting the Division to adjust the taxpayer’s NOLs carried forward from closed years would be tantamount to adjusting income reported in those years and thus constituted an impermissible audit of closed tax years. Under New Jersey law, the Division has the power to audit or investigate taxpayers and then to assess tax, but that assessment power must be applied within the four-year statute of limitations. Increasing the taxpayer’s liability in an open year based on adjustments to NOL calculations from a closed year was an indirect additional assessment of tax for a closed year that violated the statute of limitations.  The tax court was unpersuaded by the Division’s position that the IRS, as outlined in its audit manual, routinely adjusted NOLs from closed tax years that were carried forward and used in open tax years. In the court’s view, the IRS’ broad interpretation of IRC section 7602(a), which grants the IRS authority to examine any books, records or data to determine the correctness of a return, was not binding on the court and could not be applied to circumvent the New Jersey statute of limitations on audit. Having found the statute of limitations issue controlling, the court did not address whether the Division’s elimination of the NOLs was proper. However, the court noted that there appeared to be no factual basis for eliminating the NOLs.  For more information on ROP Aviation, Inc. please contact James Venere.

This Week's Developments

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Sarah McGahan

Sarah McGahan

Managing Director, State & Local Tax, KPMG US