Welcome to the inaugural edition of the Jersey Short, State Tax Notes' new column discussing all aspects of Garden State tax. You won't find much fist-pumping here (you might find some table- pounding!), but you will find fully developed analysis of important topics in just a few pages.
This column examines how New Jersey's imposition of its alternative minimum assessment on companies protected by P.L. 86-272 is probably unconstitutional. That situation presents possible refund claim opportunities, so practitioners should be mindful of New Jersey's four-year statute of limitations for filing refund claims for the state's corporation business tax.
The New Jersey Division of Taxation recently told an out-of-state retailer of tangible personal property that does not file corporation business tax (CBT) returns based on P.L. 86- 2721 protection that even if it does not owe New Jersey income tax, it should be paying the alternative minimum assessment (AMA). While the AMA technically might apply, it is unconstitutional. The company has a duty to its shareholders not to pay an unconstitutional tax, especially one that can be as high as $5 million a year.
But hasn't the AMA been repealed? How can a repealed tax be unconstitutional? Therein lies the constitutional problem: The AMA has effectively been repealed for most taxpayers but it is still imposed on companies that are protected from a net income tax by P.L. 86-272. Because only out-of-state companies can be protected by P.L. 86-272, the AMA is now imposed only on out-of-state companies. That is discrimination against interstate commerce in violation of the commerce clause.
When enacted in 2002, the AMA applied to all CBT taxpayers and ensured that all corporations would pay at least a minimum amount of tax. The State Legislature's goal was to ensure a constant stream of tax revenue, regardless of the profitability of a corporation and regardless of the company's use of so-called loopholes. Under the CBT regime, a corporation paid the greater of either a tax on entire net income, or the AMA, which was computed as a percentage of gross receipts or a percentage of gross profits (at the taxpayer's election). Because the AMA itself is not based on net income, it is not an income tax to which the protections of P.L. 86-272 could apply.2 No obvious discrimination yet.
However, for tax years beginning on or after June 30, 2006, the Legislature made a significant change to the AMA. For corporations subject to the entire net income portion of the CBT, and AMA tax rates were reduced to 0 percent on gross receipts or 0 percent on gross profits. Thus, for corporations that do not qualify for P.L. 86-272 protection in New Jersey, the AMA was effectively repealed.3 For those companies, the AMA will always be $0, making the greater of the AMA or tax on entire net income always the latter, even if only the minimum income tax ($500) is due.
However, there were no AMA rate changes for companies protected by P.L. 86-272. Therefore, for P.L. 86-272 companies, the AMA continues to be a fixed percentage of gross receipts or gross profits, a number greater than zero -- in many cases, a number much larger than $0.4
So what is the constitutional problem? The only companies that can qualify for P.L. 86-272 protection (and therefore must pay the AMA) are companies located outside New Jersey. If a company is headquartered in, has an office in, has inventory in, or has some other contact with New Jersey beyond mere solicitation, it would get the benefit of AMA equal to $0. But a company claiming P.L. 86-272 protection -- that is, an out-of-state company with only specific limited contacts in the state -- would not receive the benefit of $0 AMA and would be forced to pay the AMA based on the fixed percentages that continue to apply. That unequal treatment based on the location of a company's activities is per se discrimination under the commerce clause.
The U.S. Supreme Court has developed a test for determining when a statute is discriminatory and when a discriminatory tax will be allowed or struck down. A tax is discriminatory when it results in "differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter," the Court has said, adding, "If a restriction on commerce is discriminatory, it is virtually per se invalid."5
The AMA imposed on New Jersey companies is 0 percent, and the AMA imposed on out-of-state corporations with activities protected by P.L. 86-272 is higher than that. The regime is facially discriminatory and per se invalid.
A per se invalid tax may be saved if it "advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives."6 Courts review claims of invalid taxation with scrutiny so strict that facial discrimination is often a "fatal defect."7
One justification that has saved discriminatory taxes is the defense that the tax is compensatory. In other words, the discriminatory tax is the rough equivalent of a substantially similar tax that does not offend the Constitution.8 For example, use taxes imposed on purchases made outside the state have been upheld on the basis that they are roughly equivalent to sales taxes imposed on purchases made within a state, which do not offend the Constitution.
To save a discriminatory tax on the basis that it is compensatory, a state must identify the nondiscriminatory burden it is attempting to compensate for; show that the discriminatory tax roughly approximates, but does not exceed, the nondiscriminatory tax; and demonstrate that the two are "sufficiently similar in substance to serve as mutually exclusive 'proxies' for each other."9
The Supreme Court applied that kind of analysis in South Central Bell Telephone Co. v. Alabama, 526 U.S. 160 (1999). Alabama levied two separate taxes: Domestic companies paid a tax equal to 1 percent of the par value of their stock and foreign companies paid a tax equal to 0.3 percent of the amount of capital employed. The state argued that its facially discriminatory tax was justified because it was compensatory, but the Court had little difficulty concluding that the tax on foreign companies was not compensatory. The amounts of tax imposed were not rough approximates because domestic companies could set the par value of stock, resulting in almost no tax due, whereas foreign companies could not manipulate the value of their capital, resulting in significant tax due. Nor were the two taxes proxies for one another, according to the Court -- the domestic tax was based on ownership of shares, and the foreign tax was based on doing business in the state. It struck down the tax on foreign companies, even though the rate was lower than the tax rate for domestic companies.
New Jersey could attempt to save the AMA by arguing that it is compensatory for the tax on entire net income, which is 9 percent for domestic corporations. However, New Jersey would not be able to demonstrate that the taxes are roughly approximate. In fact, the original purpose behind the AMA was to create a different computation that took different factors into consideration. Taxpayers always pay the greater of the two, which indicates that there is no intention that they be equal or even close to each other.
New Jersey would also be unable to show that the taxes are sufficiently similar in substance to serve as mutually exclusive proxies for each other. Like the Alabama taxes in South Central Bell, the two New Jersey taxes are based on different measures: entire net income or gross receipts/gross profits. Also, the entire net income tax is subject to the restrictions imposed by P.L. 86-272, whereas the AMA may not be. Finally, the fact that until recently all New Jersey taxpayers were required to pay the greater of the two bases seriously undermines any argument that the two are mere proxies for one another.
The AMA continues to be a part of New Jersey law, so the Division of Taxation is required to administer it. However, under N.J.S.A. 54:10A-10, the director can make any adjustments necessary to reach a fair and reasonable result, and observers can hope that discretion will be exercised. While a taxpayer that receives an AMA is not likely to get meaningful relief by protesting to the Conference and Appeals Branch (the forum for informal review), the New Jersey Tax Court can invalidate an assessment based on a violation of the commerce clause.
1 P.L. 86-272 prohibits a state from imposing income tax on a company whose activities in the state are limited to the solicitation of orders of tangible personal property (and ancillary activities) so long as the orders are sent outside the state for acceptance and are not shipped from inventory maintained in the state.
2 That assumes that the AMA is a "tax" of its own and not merely a computational aspect of the entire net income portion of the CBT.
3 The New Jersey Supreme Court has said that imposing tax at the rate of 0 percent is the equivalent to imposing no tax at all. Whirlpool Properties Inc. v. Director, Division of Taxation, 208 N.J. 141 (N.J. 2011).
4 A company protected by P.L. 86-272 could forgo the protection and consent to being taxed on its entire net income, making its AMA rate 0 percent, but that raises constitutional problems of its own.
5 Oregon Waste Sys. v. Dep't of Environmental Quality of the State of Oregon, 511 U.S. 98, 99 (1994) (citing Chemical Waste Management Inc. v. Hunt, 504 U.S. 334, 344 (1992)).
6 Oregon Waste, 511 U.S. at 100-101 (citing New Energy Co. of Ind. v. Limbach, 486 U.S. 269, 278 (1988)).
7 Oregon Waste, 511 U.S. at 101 (citing Westinghouse Elec. Corp. v. Tully, 466 U.S. 388, 406-407 (1985)).
8 Oregon Waste, 511 U.S. at 103 (citing Armco Inc. v. Hardesty, 467 U.S. 638, 643 (1984)).
9 Oregon Waste, 511 U.S. at 103.
About Tax Analysts
Tax Analysts is an influential provider of tax news and analysis for the global community. Over 150,000 tax professionals in law and accounting firms, corporations, and government agencies rely on Tax Analysts' federal, state, and international content daily. Key products include Tax Notes, Tax Notes Today, State Tax Notes, State Tax Today, Tax Notes International, and Worldwide Tax Daily. Founded in 1970 as a nonprofit organization, Tax Analysts has the industry's largest tax-dedicated correspondent staff, with more than 250 domestic and international correspondents. For more information, visit our home page.
For reprint permission or other information, contact email@example.com