N.J. Admin. Code § 18:35-1.1

Current through Register Vol. 56, No. 9, May 6, 2024

Section 18:35-1.1 - Net profits from business

(a) Each taxpayer is subject to gross income tax on the taxpayer's net profits from business within the meaning of 54A:5-1.b, which shall be determined as provided in this subchapter.

(b) For purposes of the Gross Income Tax Act, a sole proprietorship, which shall include self-employed individuals and independent contractors, is a form of business in which one taxpayer owns all the assets of a business and which is not a partnership or corporation. A single member limited liability company whose member is an individual, estate, or trust shall be treated as a sole proprietorship, unless classified otherwise for Federal tax purposes. Sole proprietors shall report their income or loss as net profits from business.

(c) A taxpayer's net profits from business shall be determined by taking into account all income the taxpayer derived from the conduct of a business, profession, or any other activity intended to produce income, provided such activity qualifies and reports as a trade or business for Federal income tax purposes. All income attributable to the taxpayer's conduct of a trade or business, reduced by costs and expenses as provided in (d) below, shall be taken into account in determining the taxpayer's net profits from business. All other income of the taxpayer subject to gross income tax that is not attributable to the conduct of a trade or business shall be included in one or more of the other categories of gross income specified in 54A:5-1 according to its character and shall not be includable in the category of income net profits from business. The determination of whether income is derived from the conduct of a trade, business, or profession shall be based on an examination of facts and circumstances of the taxpayer's activities.

1. Income derived as remuneration for services rendered in the sole proprietorship's conduct of a trade or business shall be taken into account in determining a self-employed taxpayer's net profits from business. Income derived by a taxpayer in the taxpayer's capacity as an employee, as defined in 18:35-7.1, shall not be taken into account in determining the taxpayer's net profits from business, but rather shall be taxed under 54A:5-1.a (salaries, wages, etc.).

2. Interest and dividend income derived by a taxpayer in the conduct of a trade or business shall be taken into account in determining a taxpayer's net profits from business. The taxpayer shall annex to the taxpayer's return a statement demonstrating that the interest or dividends were realized in the conduct of the trade or business. Interest and dividends from investment activities or other income-producing activities which do not constitute the conduct of a trade or business shall be separately stated on the taxpayer's return and taxed either as interest described in 54A:5-1.e or dividends described in 54A:5-1.f.

3. Rental income derived by a taxpayer in the conduct of a trade or business shall be taken into account in determining a taxpayer's net profits from business. Rental income of a taxpayer that is not received in the conduct of a trade or business shall be taken into account in determining the taxpayer's net gains or net income from rents, royalties, patents, and copyrights described in 54A:5-1.d.

4. Royalty, patent, or copyright income derived by a taxpayer in the conduct of a trade or business that licenses intangible property shall be taken into account in determining the taxpayer's net profits from business. Income derived from royalties, patents, or copyrights of a taxpayer that is not derived from a trade or business shall be taken into account in determining the taxpayer's net gains or net income from, or in the form of, rents, royalties, patents, and copyrights described in 54A:5-1.d.

5. Gains from the sale, exchange, or other disposition of trade or business property shall be taken into account in determining a taxpayer's net profits from business. The taxpayer shall annex to the taxpayer's return a statement that demonstrates that gains and losses from the sale, exchange, or other disposition of property were realized in the conduct of a trade or business. The sale, exchange, or other disposition of property that is not directly related to or employed in the conduct of a trade or business must be reported as described in 54A:5-1.c, net gains or income from the disposition of property. Gain or loss from the sale or disposition of assets employed in a trade or business as a result of a complete liquidation of the business must be reported as described in 54A:5-1.c, net gains or income from the disposition of property.

i. A complete liquidation of a business is deemed to occur in the tax year when the business discontinues all business activities and all its assets have been distributed.

6. A taxpayer's distributive share of income or loss from a partnership, S corporation, or estate or trust shall not be taken into account in determining a taxpayer's net profits from business, regardless of the character of the income or nature of the activities of the partnership, S corporation, or estate or trust. Reporting of such income or loss shall be as follows:

i. Income or loss from a partnership shall be taken into account in determining the taxpayer's distributive share of partnership income described in 54A:5-1.k. For rules governing the taxation of income derived by a taxpayer from a partnership see 18:35-1.3.

ii. Income or loss from an S corporation shall be taken into account in determining the taxpayer's pro rata share of S corporation income described in 54A:5-1.p.

iii. Income from an estate or trust shall be taken into account in determining the taxpayer's net gains or income from estates or trusts described in 54A:5-1.h.

7. A taxpayer's net profits from business shall be determined in accordance with the method of accounting utilized for Federal income tax purposes. A taxpayer's net profits from business shall be determined by including any income which is subject to tax under the Gross Income Tax Act but which is exempt from Federal income taxation (for example, interest on non-New Jersey municipal obligations) and by excluding any income which is exempt from tax under the Gross Income Tax Act but which is subject to Federal income taxation (for example, interest or gains attributable to obligations described in 54A:6-14 ).

(d) A taxpayer's net profits from business shall be determined by taking into account all ordinary costs and expenses incurred in the conduct of that business. No deduction shall be allowed for taxes based on income. No deduction is permitted for any civil, civil administrative, or criminal penalty or fine. There is also no deduction for any civil, civil administrative, or criminal penalty or fine assessed and collected for a violation of a State or Federal environmental law, or any other assessment described in 54A:5-1.b(2); or any treble damages paid pursuant to N.J.S.A. 58:10-23.1 1f.a. No deduction shall be allowed for any cost or expense, which is not incurred in the conduct of the trade or business. Only ordinary business costs and expenses are deductible.

1. An ordinary business cost or expense must be:

i. Incurred primarily and directly in the pursuit of the business's income;

ii. Incurred as a common and accepted practice in that field of business;

iii. Required for and appropriate to the intended business purpose; and

iv. Reasonable in amount in relation to the intended business purpose.

2. The determination as to whether a business expense is ordinary shall be based on the facts and circumstances of the expense. A taxpayer has the burden of demonstrating to the satisfaction of the Director that the cost or expense is deductible.

i. Expenditures/contributions to Federally qualified not for profit and political organizations are not deductible as ordinary business expenses unless they meet all the criteria listed in (d)1 above.

3. Business costs or expenses that relate to business income that is exempt from tax under the Gross Income Tax Act, or which are partly or wholly nondeductible for Federal income tax purposes, may be deductible ordinary business costs or expenses under the Gross Income Tax Act. For example, meal and entertainment expenses that constitute ordinary expenses incurred in the conduct of a trade or business are fully deductible in determining a taxpayer's net profits from business even if they are only partially deductible for Federal purposes.

(e) The allocation of sole proprietorship income derived from sources either within or outside of New Jersey shall be as follows:

1. If the business activity is carried on solely within New Jersey, all items of income, gain, expense, or loss of the business are deemed to have been derived from sources within New Jersey.

2. If the business activity is carried on solely outside New Jersey, the taxpayer must complete either New Jersey Business Allocation Schedule (Form NJ-1040-NR-A) or a schedule reflecting an approved allocation method under (e)4 below. Failure to provide such schedule may result in allocation of all sole proprietorship income to New Jersey.

3. If the business activity is carried on both inside and outside New Jersey, the portion of the business's income, gains, expenses, or losses attributable to sources within New Jersey shall, except as provided in (e)4 below, be determined by use of the New Jersey Business Allocation Schedule (Form NJ-1040-NR-A). Failure to provide such schedule may result in allocation of all sole proprietorship income to New Jersey.

4. If the business activity is carried on solely outside New Jersey or both inside and outside New Jersey, and the taxpayer believes that the New Jersey Business Allocation Schedule does not provide an equitable allocation of income, gains, expenses, or losses attributable to sources inside and outside the State, and that the books and records of the business will disclose to the Director's satisfaction a more appropriate method of allocation of such items, the taxpayer may request from the Director an exception from the use of the New Jersey Business Allocation Schedule. Such request must be made in writing and set forth the basis of the request, the reason(s) why the New Jersey Business Allocation Schedule does not provide an equitable allocation, and the substitute method of allocation requested to be used. Such request shall be mailed to the New Jersey Division of Taxation, Individual Income Tax Audit Branch, PO Box 288, Trenton, NJ 08695-0288. The taxpayer shall not use the substitute method of allocation until such request is approved, in writing, by the Director. Once the Director approves a substitute method of allocation, the taxpayer cannot change it without written approval of the Director. A taxpayer must renew the request for exception from the use of the New Jersey Business Allocation Schedule every three years.

5. When a business sells some or all of its assets as a result of a liquidation, the gain or loss from the sale of real and tangible assets located in New Jersey is sourced to New Jersey. The gain or loss from the sale of real and tangible assets located outside New Jersey is sourced to the other jurisdiction.

i. The gain or loss from the sale of motor vehicle equipment is sourced to the state where the vehicle is registered, unless the vehicle was used predominantly in another state.

ii. The gain or loss from the sale of intangibles is allocated using the average of the business allocations, as set forth in (e)1 through 4 above, for the last three years.

(f) A taxpayer who is engaged in more than one trade or business as a sole proprietor must determine net profit or loss for each sole proprietorship separately. Once profit or loss from each sole proprietorship has been determined, the taxpayer must net such profits and losses and report the result in the category, net profits from business.

(g) Sole proprietor filing requirements are as follows:

1. Resident and nonresident taxpayers subject to the gross income tax shall attach to their New Jersey gross income tax return the following for each sole proprietorship:

i. Federal Schedule C or F; and

ii. A schedule detailing adjustments made to the information reported on each Schedule C or F to determine New Jersey taxable income.

2. Resident taxpayers shall report all business income regardless of source. Tax is imposed on all income.

3. Nonresident taxpayers shall report all business income regardless of source. Tax is imposed only on New Jersey source income.

(h) The provisions of this section are illustrated by the following examples:

Example 1:

Taxpayer is the sole proprietor of a hardware store. During the year the taxpayer receives the following income:

Interest from a personal savings account	$ 300+
Interest from a business checking account	$ 50++
Dividends from personal stock	$ 100+
Gross receipts from hardware sales	$ 250,000++
+ Personal income
++ Business income

Disbursements made by the taxpayer's hardware business:

Ordinary expenses--deductible			Nondeductible expenses
Cost of goods sold	$ 80,000*	Rutgers University	$ 500***
Rent	$ 20,000*
Interest Expense	$ 100*
(interest expense to finance inventory)
Supplies	$ 2,000*
Utilities	$ 1,800*
Insurance	$ 1,500*
Yellow pages	$ 200*
(advertisement)
Local Church	$ 800**
(advertisement church bulletin)
*	These are ordinary business expenses in the operation of a hardware
store and are deductible.
**	This expenditure is deductible since the taxpayer is advertising his
business in the church bulletin in hopes of attracting new customers.
***	This expenditure to Rutgers University, the taxpayer's alma mater, is
not deductible. This expenditure is not incurred primarily and directly
in the pursuit of business income, even though the taxpayer believes the
university has an excellent business program which will provide possible
future employees.

Income
Business interest	$ 50
Gross receipts from hardware sales	$ 250,000	$ 250,050
Expenses
Cost of goods sold	$ 80,000
Rent	$ 20,000
Supplies	$ 2,000
Utilities	$ 1,800
Insurance	$ 1,500
Advertisement
Yellow pages	$ 200
Local church bulletin	$ 800	($ 106,300)
Net profits from business:	$ 143,750
---------

Taxpayer will report his income on his New Jersey gross income tax return as follows:

Category	Amount
Interest	$ 300
Dividends	$ 100
Net profits from business	$ 143,750
---------
New Jersey gross income:	$ 144,150
---------

Example 2:

Taxpayers are a married/civil union couple living in New Jersey who file a joint gross income tax return. One spouse/civil union partner, who is an insurance agent, is an employee of a large insurance company. The other spouse/civil union partner is a self-employed trader of securities (stocks, bonds, futures). The couple has income from the following sources:

Non-business income		Business income
-------------------		---------------
Wages	$ 90,000	Interest	$ 4,000
(from insurance co.)		Dividends	$ 7,000
Interest	$ 10,000	Gains on sale of
(from joint savings account)		securities	$ 400,000
Dividends	$ 5,000	Losses on sale of
(non business investments held		securities	($ 100,000)
by taxpayers)
Loss on sale of stock	($ 70,000)	Income earned by
(non business investments held	the self-employed
by taxpayers)	spouse/civil
union partner as
a "trader" in
securities
Gain on sale of undeveloped land	$ 40,000

Disbursements made by the self-employed spouse/civil union partner as a trader in securities:

Ordinary expenses--deductible		Nondeductible expenses
-----------------------------		----------------------
Investment interest expense	$ 60,000*	Keogh	$ 7,500**
Broker fees	$ 5,000
Home office expense	$ 3,000
Depreciation	$ 2,000
Meals/entertainment	$ 500
Journals/publications	$ 200
Disbursements made by the employee spouse/civil union partner as an
insurance agent:
Meals/entertainment	$ 800***
Travel	$ 600***

* Investment interest expense is deductible as an ordinary business expense if it is directly related to the production of business income by the business entity incurring the cost.

** The Keogh expenditure is not deductible as an ordinary business expense. Taxpayer is not an employee of the business.

*** The employee spouse/civil union partner cannot deduct any expenses incurred in the performance of his or her duties as an insurance agent, in that he or she is an employee of the insurance company and not an independent contractor. See N.J.A.C. 18:35-1.21 and 1.23 for more detail.

The self-employed spouse/civil union partner will calculate his or her net
profits from business as follows:
Income
------
Interest	$ 4,000
Dividends	$ 7,000
Gains from sale of securities	$ 400,000
Losses from sale of securities	($ 100,000)	$ 311,000
-----------
Ordinary expenses
-----------------
Investment interest expense	$ 60,000
Broker fees	$ 5,000
Home office expense	$ 3,000
Depreciation	$ 2,000
Meals/entertainment	$ 500
Journals/publications	$ 200	($ 70,700)
-----	----------
Net profits from business:	$ 240,300
---------
Taxpayers will report their income on their New Jersey gross income tax
return as follows:
Wages	$ 90,000
Interest	$ 10,000
Dividends	$ 5,000
Net profits from business	$ 240,300
Net income from disposition of property	$ 0	+
New Jersey gross income:	$ 345,300
---------
+	Net income from disposition of property
Loss on sale of stock	($ 70,000)
Gain on sale of undeveloped land	$ 40,000
--------
Net income from disposition of	($ 30,000)
property:	----------

Taxpayers cannot apply their loss on disposition of property against their income attributable to other categories of New Jersey gross income.

Example 3:

Taxpayers are a married/civil union couple living in New Jersey who file a joint gross income tax return. One of the spouses/civil union partners is employed by a large medical firm. The other spouse/civil union partner operates a rental real estate business at the Jersey shore which he or she personally manages and reports on Schedule C of their Federal return. The taxpayers also own a cabin in Killington, Vermont as an investment. They report the income from the cabin as rental income on their Federal return(s). The property in Vermont is managed by a realty company that handles all aspects of renting and maintaining the property. The couple has income from the following sources:

Rental real estate business income		Non business income
----------------------------------		-------------------
Rental receipts	$ 200,000	Wages from medical	$ 100,000
firm
Interest	$ 500	+	Interest from	$ 6,000
investments
Dividends from	$ 5,000
investments
Rental receipts from	$ 12,000
VT property
+	Interest earned on working capital

Disbursements made by the rental real estate business and by the taxpayers for the Vermont rental property:

Rental real estate business		Vermont rental property
---------------------------		-----------------------
Ordinary expenses--	Ordinary expenses--
deductible	deductible
Depreciation	$ 22,000	Depreciation	$ 4,000
Utilities	$ 15,000	Utilities	$ 800
Mortgage	$ 13,000	*	Mortgage	$ 6,000	*
interest	interest
Taxes	$ 8,000	Taxes	$ 5,200
Repairs	$ 5,000	Commissions	$ 1,000
Advertising	$ 800

* Interest paid to banks for the purchase of the rental properties.

Taxpayers will calculate their net profits from business and rental income as follows:

Rental real estate business			Vermont rental property
---------------------------		-----------------------
Income	Income
Rental receipts	$ 200,000	Rental receipts	$ 12,000	$ 12,000
--------
Interest	$ 500	$ 200,500
-----
Ordinary expenses	Ordinary expenses
Depreciation	$ 22,000	Depreciation	$ 4,000
Utilities	$ 15,000	Utilities	$ 800
Mortgage interest	$ 13,000	Mortgage interest	$ 6,000
Taxes	$ 8,000	Taxes	$ 5,200
Repairs	$ 5,000	Commissions	$ 1,000	($ 17,000)
----------
Advertising	$ 800	($ 63,800)
----------
Net profits from	$ 136,700	Net rental income:	($ 5,000)
business	---------	---------

Taxpayers will report their income on their New Jersey gross income tax return as follows:

Wages	$ 100,000
Interest	$ 6,000
Dividends	$ 5,000
Net profits from business	$ 136,700
Net gains or income from rents, royalties, patents	$ 0	+
and copyrights	---
New Jersey gross income:	$ 247,700
---------
+	Taxpayers cannot apply their rental loss of $ 5,000 against income
attributable to other categories of New Jersey gross income.

Example 4:

A New Jersey resident starts a sole proprietorship business, operating in New Jersey, with an original contribution of $ 2,300. Prior to the end of the calendar year, taxpayer sells the business including all assets (office equipment and a truck). The business had $ 400.00 of current ordinary income, $ 100.00 of interest, and $ 10,000 of gain from sale of assets. The taxpayer reports income as follows:

Income
Sales	$ 20,000
Interest	$ 100
Total receipts from business	$ 20,100
Ordinary Expenses
Salary	$ 9,000
Cost of sales	$ 8,000
Depreciation	$ 2,600	($ 19,600)
Net profit from business	$ 500
Net gain from disposition of property	$ 10,000

The taxpayer will report $ 500.00 net profit from business and $ 10,000 net gain from disposition of property.

Example 5:

A nonresident operates a sole proprietorship business in New Jersey and Pennsylvania with 60 percent of the profits allocated to New Jersey and 40 percent allocated to Pennsylvania. The profit for the operation of the business was $ 20,000 for the year. Prior to the end of the calendar year, taxpayer sells the business including all the assets in a complete liquidation. The assets include two parcels of real property. The parcel in New Jersey sold at a gain of $ 10,000 and the parcel in Pennsylvania sold at a gain of $ 7,000. Additionally, taxpayer sold equipment, inventory, and other tangible assets at a gain of $ 5,000 of which $ 2,750 was sourced to New Jersey.

Gain from complete liquidation
Everywhere	New Jersey
Gain from real property	$ 17,000	$ 10,000
Gain from tangible assets	$ 5,000	$ 2,750
-------	-------
Gain from complete liquidation	$ 22,000	$ 12,750
--------	--------

The taxpayer reports income as follows on his nonresident New Jersey gross income tax return.

Everywhere	New Jersey
Net profit from business	$ 20,000	$ 12,000
Gain or loss from disposition of property	$ 22,000	$ 12,750
--------	--------
Total	$ 42,000	$ 24,750

N.J. Admin. Code § 18:35-1.1

Amended by 48 N.J.R. 295(a), effective 2/16/2016