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New Jersey Tax Court Finds "User Error" in Treatment of Extraterritorial Income

The New Jersey Tax Court sent a strong message to the New Jersey Division of Taxation that the Legislature—and not the Division—sets the bounds of state taxation. IBM Corp. v. Dir., Div. of Taxation, No. 011630-2008 (N.J. Tax Ct. Jan. 26, 201

March 11, 2011

The New Jersey Tax Court sent a strong message to the New Jersey Division of Taxation that the Legislature—and not the Division—sets the bounds of state taxation. IBM Corp. v. Dir., Div. of Taxation, No. 011630-2008 (N.J. Tax Ct. Jan. 26, 2011). The Division issued Notices of Assessment associated with the add back of extraterritorial income deducted in the computation of federal taxable income pursuant to I.R.C. § 114(e).

The Division issued Notices of Assessment to IBM Corp. (IBM) and Crestron Electronics, Inc. (Crestron) that adjusted their income to include extraterritorial income in New Jersey taxable income. IBM and Crestron argued that New Jersey taxable income was directly linked to federal taxable income as reported on line 28 of the federal tax return—which did not include the extraterritorial income. Further, while New Jersey makes certain adjustments to the federal taxable income amount, none of the adjustments relate to the inclusion of extraterritorial income. The Tax Court held that the Division’s erroneous reading of the state’s taxable income definition and the Division’s expansive reading of its own regulation, did not justify the Division’s position.

As state tax authorities are becoming increasingly creative in their quest to find more revenue, the decision is a welcome reminder of the limits on statutory authority. Although it is unclear whether the Division of Taxation will appeal, and I.R.C. § 114 has since been repealed, those who included extraterritorial income in their New Jersey tax returns should consider filing refund claims.

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