Opinion
Docket No. 008689-2008
11-21-2013
Re: Michael and Inge Trachtenberg v. Director, Division of Taxation
David C. Freinberg, Esq. LaClairRyan Two Penn Plaza East David Trachtenberg, Esq. Trachtenberg, Rodes & Friedberg, LLP Ramanjit K. Chawla Deputy Attorney General Division of Law R.J. Hughes Justice Complex
NOT FOR PUBLICATION WITHOUT APPROVAL OF
THE TAX COURT COMMITTEE ON OPINIONS
Patrick DeAlmeida
Presiding Judge
David C. Freinberg, Esq.
LaClairRyan
Two Penn Plaza East
David Trachtenberg, Esq.
Trachtenberg, Rodes & Friedberg, LLP
Ramanjit K. Chawla
Deputy Attorney General
Division of Law
R.J. Hughes Justice Complex
Dear counsel:
This letter constitutes the court's opinion on the parties' cross-motions for summary judgment in the above-referenced matter. At issue is the June 13, 2008, final determination of the Director, Division of Taxation assessing gross income tax against plaintiffs for tax year 2004. * For the reasons stated more fully below, plaintiffs' motion for summary judgment is denied, the Director's motion for summary judgment is granted and a judgment affirming the Director's final determination will be entered by the court.
I. Findings of Fact
Based on the materials submitted by the parties in support of their motions, the court makes the following findings of fact. Plaintiffs Michael and Inge Trachtenberg, a married couple, resided together in Englewood. During tax year 2004, plaintiffs earned $500,000 in wages. Of that amount, $117,300 was attributable to New York. Plaintiffs also earned taxable interest income of $6,125 and dividend income of $29, both attributable to New Jersey.
Also during 2004, the couple realized capital gains of $10,406,870 from the sale of real property in New York and $111 in capital gains from the sale of stock taxed only by New Jersey. For New Jersey gross income tax purposes, plaintiffs were permitted to offset their capital gains by capital losses they incurred during 2004 in the amount of $6,174,810. Thus, New Jersey gross income tax was assessed against only $4,232,171 of the capital gains realized by plaintiffs ($10,406,870 + $111 - $6,174,810 = $4,232,171). New York did not permit the capital gains realized by plaintiffs to be offset by their capital losses. New York, however, allowed plaintiffs to deduct from their taxable income $713,708 in rental losses not recognized by New Jersey. Pursuant to N.J.S.A. 54A:5-2, for New Jersey gross income tax purposes losses may offset income only from the same category as the loss. Because plaintiffs did not report New Jersey rental income their rental losses did not reduce their taxable New Jersey income.
The allocation of plaintiffs' 2004 income between New York and New Jersey is accurately depicted as follows:
New York State
New Jersey
Wages
$ 117,300
$ 500,000
Interest
$ 0
$ 6,125
Dividends
$ 0
$ 29
Capital Gains
$10,406,870
$10,406,981
Capital Losses
$ 0
($ 6,174,810)
Rental Losses
($ 713,708)
$ 0
Total Income
$ 9,810,462
$ 4,738,325
Plaintiffs filed a timely New Jersey gross income tax return for 2004. As detailed above, they reported total New Jersey income of $4,738,325. Plaintiffs took a $5,000 exemption and deducted $67,456 in medical expenses as permitted by law. They reported New Jersey taxable income of $4,665,869 ($4,738,325 - $5,000 - $67,456 = $4,665,869). Plaintiffs reported a New Jersey gross income liability of $401,486.
Plaintiffs thereafter calculated a credit against their 2004 New Jersey gross income tax liability for the income tax they paid to New York State. N.J.S.A. 54A:4-1 defines the credit authorized by the Legislature for New Jersey residents:
(a) A resident taxpayer shall be allowed a credit against the tax otherwise due under this act for the amount of any income tax or wage tax imposed for the taxable year by another state of the United States or political subdivision of such state, or by the District of Columbia, with respect to income which is also subject to tax under this act . . . .
(b) The credit provided under this section shall not exceed the proportion of the tax otherwise due under this act that the amount of the taxpayer's income subject to tax by the other jurisdiction bears to his entire New Jersey income.
The Director adopted regulations establishing a formula to determine the amount of credit due to a New Jersey resident taxpayer under the statute. The formula includes a fraction, the numerator of which is equal to the taxpayer's income subject to tax by the other jurisdiction before the allowance of deductions and exemptions and the denominator of which is equal to the taxpayer's entire New Jersey income. N.J.A.C. 18:35-4.1(a)3 provides:
N.J.S.A. 54A:4-1(b), (c) and (d) provide for a limitation on the credit for tax paid to another state or political subdivision. The amount of the resident taxpayer credit for tax paid to another state or political subdivision shall not exceed the percentage derived by dividing income subject to tax in the other jurisdiction by the taxpayer's entire New Jersey income multiplied by the tax otherwise due under the New Jersey Gross Income Tax Act.
The Division's regulations define the elements of the formula as follows:
For purposes of determining the percentage, as provided in (a)3 above, for limitation of the tax credit:The Director further explains that
i. Income subject to tax by the other jurisdiction means those items of income which are taxed by another jurisdiction before the allowance for personal exemptions and standard and/or other itemized deductions and which are also subject to tax under the New Jersey Gross Income Tax Act.
ii. Entire New Jersey income means the New Jersey gross income subject to tax before allowances for personal exemptions and deductions.
[N.J.A.C. 18:35-4.1(a)6(i) and (ii).]
The credit against New Jersey tax applies with respect to the income tax or wage tax paid in the other state or political subdivision thereof on income which is also subject to tax under the New Jersey Act. Therefore, there shall be excluded from the income in the other state any income which is not subject to tax under the New Jersey law.
[N.J.A.C. 18:35-4.1(a)(2).]
Subject to this limitation, the formula for determining the resident credit for taxes paid to other jurisdictions is correctly depicted as:
Income subject to tax by other jurisdiction
before allowance for exemptions and deductions/Entire New Jersey income x New Jersey Tax = Credit
When calculating the credit for tax year 2004, plaintiffs included in the numerator of the fraction all of the income taxed by New York, deducting only the $713,708 in rental losses recognized by that State. Plaintiffs' formulation of their credit can be expressed as follows:
$9,810,462/$4,738,325 x $401,486 = $831,237 (rounded)This formulation of the credit did not take into account the fact that New Jersey permitted plaintiffs to offset their capital gains with capital losses totaling $6,174,810. As a result, plaintiffs included in the numerator income that was taxed by New York State, but not taxed by New Jersey. In addition, although plaintiffs deducted from their New York income the $713,708 rental loss recognized by that State, they did not account for the fact that New Jersey did not recognize that loss. Thus, plaintiff included in the numerator income taxed by New Jersey but not taxed by New York
The calculated credit exceeded the amount of tax plaintiffs paid to New York State ($745,821). Because the resident credit cannot exceed the amount of tax paid to another jurisdiction, plaintiffs applied a credit of $401,486. Application of this credit to plaintiffs New Jersey gross income tax liability of $401,486 reduced plaintiffs' final 2004 New Jersey gross income tax liability to $0. As a result of withholdings ($22,259), previous payments of estimated tax ($50,000) and a claimed property tax credit ($50), plaintiffs sought a refund of $72,309 ($22,259 + $50,000 + $50 = $72,309). The Director thereafter issued a refund in that amount to plaintiffs in two checks.
After an audit, the Division determined that plaintiffs had miscalculated the resident credit. In an August 30, 2007 notice of deficiency, a Division auditor explained that the numerator of the resident credit formula cannot include income that was taxed by the foreign jurisdiction but not taxed by New Jersey. The auditor recalculated the resident credit by including in the numerator only the $4,232,171 in capital gains taxed by New Jersey. When this amount of capital gains was combined by the auditor with the $117,300 in wages taxed by both New Jersey and New York, the resulting revised credit fraction numerator was $4,349,471 ($4,232,171 + $117,300 = $4,349,471). These are the only two categories of income taxed by both States. The auditor did not account for the $713,708 rental loss recognized by New York State, but not recognized by New Jersey, because the capital loss recognized by New Jersey exceeded the rental loss recognized by New York State. To deduct both amounts from the numerator would overstate the amount of income not taxed by both jurisdictions by double counting the $713,708.
The auditor recalculated plaintiffs' credit as follows:
$4,349,471/$4,738,325 x $401,486 = $368,538
Because the allowable credit ($368,538) exceeded the amount of tax plaintiffs paid to New York State on only the income taxed by both States ($330,169), the auditor determined that plaintiffs were entitled to a credit of $330,169. Were plaintiffs to be awarded a credit of $368,538 they would receive credit for $38,369 in taxes they paid to New York State on income that was not also taxed by New Jersey. (Plaintiffs' actual tax payment to New York State was $745,821 because plaintiffs paid tax to New York State on income that was not subject to tax by New Jersey). Plaintiffs' New Jersey credit, therefore, was reduced by the auditor to $330,169.
After awarding plaintiffs a $10,000 deduction for local property taxes to which they were entitled but had not claimed, and applying the credit of $330,169, the auditor determined that plaintiffs had a 2004 New Jersey gross income tax liability of $70,420. After assessment of a 5% late payment penalty and interest to September 29, 2007, the auditor determined plaintiffs' outstanding 2004 New Jersey gross income tax liability, including the amount previously refunded, to be $92,353.
Plaintiffs thereafter requested an administrative hearing to challenge the notice of deficiency. On April 7, 2008, after an administrative hearing, the Director issued a final determination largely agreeing with the conclusions set forth in the notice of deficiency. A further adjustment was made to the numerator of the resident credit. First, the Director removed from the numerator plaintiffs' $111 in capital gains from the sale of stock. Because stock is an intangible asset its taxable locus for income tax purposes is the State of residence of the taxpayer. Thus, only New Jersey could tax that income. Next, the Director changed the capital losses allowed by New Jersey to $6,174,435. In all other documents (including on the same page of the final determination) this figure is reported as $6,174,810. The $375 difference is not explained in the final determination. However, as demonstrated below, the $375 differential is immaterial because the available credit remains the same as reported in the notice of deficiency using either figure.
The revised numerator in the final determination is $4,349,735 ($117,300 + $10,406,870 - $6,174,435 = $4,349,735). This results in the same available resident credit as reported in the notice of deficiency:
$4,349,735/$4,738,325 x $401,486 = $368,560
Because the allowable credit ($368,560) exceeded the amount of tax plaintiffs paid to New York State on the income taxed by both States ($330,169), the Director determined that plaintiffs were entitled to a credit of $330,169. After adjusting and updating the interest through May 15, 2008, the final determination assessed a balance due of $89,780.
On June 13, 2008, the Director issued another final determination. The second final determination increased plaintiffs' credit to $330,688. The increase in the credit is the result of the fact that the first final determination changed the amount of income subject to tax by both New Jersey and New York State. The tax plaintiffs paid to New York on the revised amount was $330,688. The available credit, therefore, increased to the same amount. After making that change and calculating interest through July 15, 2008, the Director set plaintiffs' 2004 New Jersey gross income tax liability, including interest, to be $90,095.
On July 3, 2008, plaintiffs filed a Complaint in this court challenging the June 13, 2008 final determination. After discovery, the parties cross-moved for summary judgment.
II. Conclusions of Law
Summary judgment should be granted where "the pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact challenged and that the moving party is entitled to a judgment or order as a matter of law." R. 4:46-2. In Brill v. Guardian Life Ins. Co., 142 N.J. 520, 523 (1995), our Supreme Court established the standard for summary judgment as follows:
[W]hen deciding a motion for summary judgment under Rule 4:46-2, the determination whether there exists a genuine issue with respect to a material fact challenged requires the motion judge to consider whether the competent evidential materials presented, when viewed in the light most favorable to the non-moving party in consideration of the applicable evidentiary standard, are
sufficient to permit a rational factfinder to resolve the alleged disputed issue in favor of the non-moving party.
The court finds that there are no disputed material facts at issue in this matter. The sole issue before the court is the correct calculation, in light of the undisputed facts, of plaintiffs' gross income tax resident credit under N.J.S.A. 54A:4-1 for tax year 2004. Plaintiffs' claims, therefore, are ripe for resolution.
The court's analysis of the validity of the Director's final determination begins with the familiar principle that the Director's interpretation of tax statutes is entitled to a presumption of validity. "Courts have recognized the Director's expertise in the highly specialized and technical area of taxation." Aetna Burglar & Fire Alarm Co. v. Director, Div. of Taxation, 16 N.J. Tax 584, 589 (Tax 1997)(citing Metromedia, Inc v. Director, Div. of Taxation, 97 N.J. 313, 327 (1984)). The scope of judicial review of the Director's decision with respect to the imposition of a tax "is limited." Quest Diagnostics, Inc. v. Director, Div. of Taxation, 387 N.J. Super. 104, 109 (App. Div.), certif. denied, 188 N.J. 577 (2006). The Supreme Court has directed courts to accord "great respect" to the Director's application of tax statutes, "so long as it is not plainly unreasonable." Metromedia, supra, 97 N.J. at 327. See also GE Solid State, Inc. v. Director, Div. of Taxation, 132 N.J. 298, 306 (1993)("Generally, courts accord substantial deference to the interpretation an agency gives to a statute that the agency is charged with enforcing.").
In addition, a regulation promulgated by the Director must be upheld unless the taxpayer can demonstrate that the regulation is "arbitrary, capricious, unduly onerous or otherwise unreasonable." Sorensen v. Director, Div. of Taxation, 2 N.J. Tax 470, 476 (Tax 1981)(citing New Jersey Guild of Hearing Aid Dispensers v. Long, 75 N.J. 544 (1978)). Only a regulation that is "out of harmony with the statute" will be invalidated by the court as exceeding delegated authority to interpret the law. Ibid. A regulation "within the fair contemplation of the delegation of the enabling legislation" will be upheld. Ibid.
N.J.S.A. 54A:4-1 defines the parameters of the credit for residents who pay income tax to New Jersey and other jurisdictions on the same income:
(a) A resident taxpayer shall be allowed a credit against the tax otherwise due under this act for the amount of any income tax or wage tax imposed for the taxable year by another state of the United States or political subdivision of such state, or by the District of Columbia, with respect to income which is also subject to tax under this act . . . .
(b) The credit provided under this section shall not exceed the proportion of the tax otherwise due under this act that the amount of the taxpayer's income subject to tax by the other jurisdiction bears to his entire New Jersey income.
The objective of N.J.S.A. 54A:4-1 is to avoid double taxation of income earned by New Jersey residents. As the Appellate Division explained, "if the same income is taxed in another state and in this state for the same tax year, the Legislature intends the New Jersey resident taxpayer to receive a credit for the tax paid in the other state." Sutkowski v. Director, Div. of Taxation, 312 N.J. Super. 465, 474-75 (App. Div. 1998). "The credit is available to New Jersey residents for any income tax or wage tax imposed by another state with respect to income which is also subject to tax by New Jersey." Sorensen, supra, 2 N.J. Tax at 471.
The statute imposes two limitations on the credit: (1) paragraph (a) allows a credit up to, but not greater than, the actual amount of taxes paid to the other jurisdiction on income also subject to tax by New Jersey; and (2) paragraph (b) further limits the credit by multiplying the New Jersey gross income tax due without regard to the credit by the ratio which is the amount of the taxpayer' s income subject to tax by the other jurisdiction divided by his entire New Jersey income. Willett v. Director, Div. of Taxation, 10 N.J. Tax 402, 405-06 (Tax 1989).
The outcome in this matter is controlled by the holding in Allen v. Director, Div. of Taxation, 14 N.J. Tax 385 (Tax 1994), affd o.b., 15 N.J. Tax 704 (App. Div. 1996). The issue before the court in Allen is precisely the issue presented by the parties here:
The specific issue is how to calculate the numerator of the fraction prescribed in N.J.S.A. 54A:4-1(b). The Director of the Division of Taxation ("Director") contends that the taxpayers' capital loss (deductible in New Jersey but not in New York) and his rental loss (deductible in New York but not in New Jersey) should both be subtracted from income when calculating the numerator of the fraction. The taxpayers' position is that only the greater of the two figures, the capital loss, should be subtracted from income when calculating the numerator. For the reasons explained below, I have concluded that the taxpayers are correct.Similar to plaintiffs, the taxpayers in Allen were New Jersey residents who realized a capital gain from the sale of real estate in New York State and had two deductions from income: capital losses recognized only in New Jersey and losses from the operation of rental properties recognized only in New York. Ibid. As Judge Small explained in Allen:
[Id. at 387.]
In this case, the dispute arises from the existence of two distinct deductions, one allowable only in New Jersey and one allowable only in New York. Moreover, the New Jersey deduction is larger than the New York deduction, thereby resulting in New Jersey income which is less than New York income for the purpose of computing the credit fraction numerator.The taxpayers in Allen argued "that since both items serve to reduce taxable income . . . the required deduction from the numerator of the fraction is the larger amount." Ibid. The Director, on the other hand, argued "that the allowable credit fraction should be further reduced by the separate rental loss amount which is deductible only in New York but not in New Jersey." Ibid. After a careful analysis of the history and purpose of the resident credit provision, the Allen court held that the "two reductions of income which are not common to New York and New Jersey should reduce the numerator of the fraction by the greater of the two off-setting amounts, not by their sum." Id. at 392.
[Id. at 391.]
As the Allen court noted, "[t]he intent of the credit provision of the New Jersey Gross Income Tax Act is to minimize or avoid double taxation [and the] calculation of the credit is intended to shield income taxed by another jurisdiction." Id at 389 (quoting Nielsen v. Director, Div. of Taxation, 4 N.J. Tax 438, 442 (Tax 1982)). To reduce from the numerator by both categories of losses, one of which was recognized only by New Jersey and one of which was recognized only by New York, would overstate the amount of income not taxed by both jurisdictions.
Judge Small stated his conclusion succinctly, "I find that under the circumstances in this case the total amount of reduction of the credit fraction numerator cannot exceed the total amount by which income is reduced in any one state. Put another way, in this case, in calculating the credit fraction numerator, deductions from income cannot exceed the total amount of deductions from income in that state in which the total deductions are greater, in this case New Jersey." Id. at 393. The Appellate Division affirmed this court's holding "substantially for the reasons stated by Judge Small." Allen v. Director, Div. of Taxation, 15 N.J. Tax 704, 705 (App. Div. 1996).
The facts giving rise to the decision in Allen and those presently before the court are substantively indistinguishable. In both cases, New Jersey residents realized capital gains. In both cases, New Jersey allowed an offset of those gains with capital losses not recognized by New York. In both cases, New York recognized an offset attributable to rental activities not recognized by New Jersey. In both cases, the offset recognized by New Jersey was larger than the offset recognized by New York. There is no meaningful difference between the two sets of facts. In Allen, the Appellate Division affirmed the very position taken by the Director here with respect to the calculation of the taxpayers' resident credit.
Judge Crabtree plainly stated the obligations of this court in such circumstances. "Trial courts are free to disagree with appellate opinions; they are not free to disobey." Tuition Plan v. Director, Div. of Taxation, 4 N.J. Tax 470, 485 (Tax 1982) (citing Reinauer Realty Corp. v. Borough of Paramus, 34 N.J. 406 (1962); Dunham's & Co. v. Dzurinko, 125 N.J. Super. 296 (App. Div. 1973)). Accord Weir v. Market Transition Facility, 318 N.J. Super. 436, 448 (App. Div.)("The trial court may disagree with our published decisions but it is obligated to comply with the procedures we mandate within them."), certif. denied, 160 N.J. 477 (1999). The matter having been resolved by the Appellate Division, the Director is entitled to summary judgment in his favor.
That is not to say that in the absence of controlling appellate precedent this court would reach a different result. It is undisputed that New Jersey taxed less of plaintiffs' 2004 income than did New York. The purpose of N.J.S.A. 54A:4-1 is to provide a credit for taxes paid to other jurisdictions on income also subject to tax in New Jersey. Here, New Jersey did not tax more than $6.1 million in capital gains taxed by New York State. To not exclude that amount from the numerator of the resident credit would provide plaintiffs with an inflated credit, awarding them relief from their New Jersey income tax obligation for taxes imposed on income not subject to double taxation. The purpose of the resident credit is to provide relief from New Jersey taxes where income is taxed by both New Jersey and another jurisdiction and not to provide a credit against New Jersey taxes for levies that New Jersey residents might encounter in other jurisdictions on income not subject to tax in their home state.
Nor is the court convinced by plaintiffs' argument regarding the instructions accompanying the 2004 New Jersey Gross Income tax return, which they claim are misleading. Schedule A, on which the resident credit is calculated, contains Line 1 entitled "[i]ncome actually taxed by other jurisdiction during the tax year (indicate name __)," and Line 2 entitled "[i]ncome subject to tax by New Jersey (From Line 29, Form NJ-1040)." The instructions accompanying Schedule A at page 45 plainly explain the Director's position:
Enter on Line 1 the amount of income you receive during the year which was actually taxed by the other jurisdiction.
* * *
Any income included on Line 1 of Schedule A must also be included on Line 2 since to be eligible for the credit, the income must be taxed by both New Jersey and the other jurisdiction.
* * *
Do not include on Line 1:
* Income which is not subject to New Jersey income tax (even though the item(s) may be subject to tax by the other jurisdiction, e.g., unemployment compensation).
The instructions put plaintiffs on notice that the numerator of the resident credit fraction, i.e. Line 1, should contain only income that was subject to tax by both New York and New Jersey. There is nothing misleading about the above-quoted instructions. Because of the $6,174,810 capital loss recognized by New Jersey (but not by New York), New Jersey taxed only $4,738,325 of income also subject to tax by New York. These instructions are entirely consistent with the text of N.J.S.A. 54A4-1, the resident credit statute, the Director's regulations interpreting the statute, and the Appellate Division's holding in Allen, issued eight years before the deadline for filing 2004 New Jersey gross income tax returns.
Even if the instructions were considered to be ambiguous, a finding with which the court does not agree, the instructions cannot provide a greater credit than is allowed by the statute. The Director must act within the scope of his statutory authority. N.J.S.A. 54A:4-1 provides for a limited credit, applicable only to non-New Jersey source income that is taxed both by New Jersey and other jurisdictions. The resident credit amounts to a limited waiver of the State's taxing authority by the Legislature. Tax return instructions drafted by the Division of Taxation cannot expand the credit beyond its legislatively defined parameters. The statute has consistently been interpreted by the Director and the courts to afford a credit only in those instances which a resident taxpayer's income is taxed both by New Jersey and another jurisdiction.
Nor is there significance to the fact that the taxpayers in Allen correctly stipulated that the capital losses recognized by New Jersey should be deducted from their New York income in the numerator of the resident credit fraction. The court in Allen examined facts that are nearly identical to those presented here and set forth the correct method for application of the resident credit fraction. The Appellate Division affirmed that holding more than seventeen years ago and the Legislature has taken no steps to amend the statute to alter that court's holding. The mere fact that the Allen taxpayers stipulated to a step in calculating the resident credit does not in any way dilute Judge Small's legal conclusion, later adopted by the Appellate Division, that the stipulation was correct. The method for calculating the resident credit established in Allen fully effectuates the purpose of the resident credit statute when applied in this case. The $6,174,810 capital loss recognized by New Jersey reduced by more than $6 million the amount of income taxed by this State. A failure to recognize that deduction would grant to plaintiffs a credit to which they are not entitled.
Plaintiffs' payment of $745,821 in income tax to New York State is not relevant to the determination of whether they have been subjected to impermissible double taxation. It is not a comparison of the amount of tax that New Jersey and a foreign jurisdiction collected from New Jersey residents in a particular year that determines whether double taxation has taken place. The operative inquiry is whether New Jersey residents paid income tax to both New Jersey and New York on the same income. Here, because New York did not recognize a substantial capital loss that was recognized by New Jersey, New York taxed approximately $6 million more of plaintiffs' income for tax year 2004 than did New Jersey. As a result, plaintiffs paid significantly more in taxes to New York than to New Jersey, which imposed its income tax on a smaller amount of income. The resident credit statute is not designed to ameliorate the effects of decisions by other States to tax income that is not subject to tax in New Jersey. The resident credit is not a panacea for the taxing practices of other jurisdictions. The statute is designed to address the limited circumstances in which both New Jersey and another State tax the same income earned by a New Jersey resident.
Plaintiffs also argue that, even if the Director's legal position is adopted by the court, the Director incorrectly calculated plaintiffs' 2004 resident credit. The alternative calculations offered by plaintiffs, however, are not convincing. The Director's calculation of the credit accurately reflects the credit authorized by N.J.S.A. 54A:4-1.
A judgment affirming the Director's June 13, 2008 final determination will be issued by the court.
Very truly yours,
Patrick DeAlmeida, P.J.T.C.