This is a matter under N.J.S.A. 54A:1-1 et seq., the New Jersey Gross Income Tax Act, in which taxpayers seek to set aside an assessment made by defendant in the amount of $496.12 for the tax year 1977. In addition, there was a penalty of $24.81 and interest in the amount of $105.17.
The dispute between the parties involves the deductibility of interest expense incurred by taxpayers in connection with a margin account they maintained during the tax year for the purchase of securities. Taxpayers urge two arguments for deductibility of such interest expense: (1) the purchase and sale of securities by them for their own personal pecuniary benefit constitutes a trade or business in accordance with N.J.S.A. 54A:5-1(b), and interest expense incurred in connection with the purchase of such securities is a business expense properly deductible by them from their income, or (2) in the alternative, the interest expense incurred by them in connection with their margin account is properly deductible from their investment income consisting of dividend income and interest income.
Defendant contends that the activities engaged in by taxpayers of purchasing securities for their own account did not constitute a trade or business under the Gross Income Tax Act, and, since the income tax is a gross income tax, only those deductions specified in the statute are permissible. He argues that since the statute does not permit deduction of interest expense in connection with investment income, such expense is not deductible.
Plaintiffs filed their 1977 New Jersey Gross Income Tax Return showing wages of $37,644 and other income of $36,222. In calculating their other income, plaintiffs listed various receipts, including interest, dividends and capital gains. From such receipts plaintiffs then made various deductions, including margin account interest, interest on a line of credit, bond interest and real estate expenses and depreciation. Defendant adjusted the taxpayers' income by disallowing all the deductions made by them in calculating their other income. Prior to hearing, the parties settled their differences except for margin account interest.
After the matter was scheduled for trial defendant filed and served a motion for summary judgment returnable on the trial date. In response to defendant's motion, plaintiffs submitted a letter in opposition to the motion, setting forth various facts and presenting legal argument. On the return day of the motion plaintiff husband recited certain facts in open court which he was permitted to do in lieu of an affidavit in opposition to the motion of defendant. The facts recited were stipulated to by defendant, and the matter may be disposed of on the motion without taking further testimony.
The stipulated facts disclose that plaintiffs purchased securities and financed 50% of the purchase price with margin loans. Plaintiff husband is in the Air National Guard on active duty as commander of the 177th Fighter Intercepter Group of the New Jersey Air National Guard. For the tax year in question his unit had an operational five-minute alert commitment at the National Aviation Facilities Experimental Center in Pomona, New Jersey, to which air station the group was assigned. Plaintiff husband contends that he is engaged in more than one business: he has his position as group commander and he is in the securities business.
The New Jersey Gross Income Tax Act, N.J.S.A. 54A:1-1 et seq., is a broad-based, personal income tax applicable to income of resident and nonresident individuals, estates and trusts. Gross income under the statute, so far as pertinent to the matter presently before the court, includes salaries and wages, net profits from business, net gains from disposition of property, interest and dividends. N.J.S.A. 54A:5-1(a), (b), (c), (e) and (f). Deductions from gross income to arrive at taxable income are allowed for personal exemptions, school age dependents, alimony and separate maintenance payments and medical expenses. N.J.S.A. 54A:3-1, 1.1, 2 and 3. Income of certain types is excludable, such as interest on certain obligations. N.J.S.A. 54A:6-14. The nature of the tax on gross income, as defined, is further emphasized by the provision on losses which specifically provides that "a net loss in one category of gross income may not be applied against gross income in another category of gross income." N.J.S.A. 54A:5-2.
The first issue is whether taxpayers' activities constituted the "operation of a business, profession, or other activity" under N.J.S.A. 54A:5-1(b), so that only net income from security transactions, i.e., after deduction of margin interest, was taxable.
In Higgins v. Commissioner, 312 U.S. 212, 61 S. Ct. 475, 85 L. Ed. 783 (1941), reh. den. 312 U.S. 714, 61 S. Ct. 728, 85 L. Ed. 145 (1941), the Supreme Court concluded that the management of one's investments does not constitute the carrying on of a trade or business. Higgins had "extensive investments in real estate, bonds and stocks, devoted a considerable portion of his time to the oversight of his interests and hired others to assist him in offices rented for that purpose." Id. at 213, 61 S. Ct. at 476. He claimed a deduction for salaries and other expenses associated with the management of his investments as expenses incurred in carrying on a trade or business.*fn1 The Board of Tax Appeals, the United States Court of Appeals for the Second Circuit, and finally, the United States Supreme Court, all concluded that the expenses incurred by Higgins in managing his investments were not deductible as trade or business expenses.*fn2 In each case the court concluded that Higgins was not in business. The Supreme Court said:
The petitioner merely kept records and collected interest and dividends from his securities, through managerial attention for his investments. No matter how large the estate or how continuous or extended the work required may be, such facts are not sufficient as a matter of law to permit the courts to reverse the decision of the Board. [at 218, 61 S. Ct. at 478]
The Second Circuit reasoned:
By the common speech of men, a person who does nothing beyond looking after his own investments and receiving the income from them is not conducting a trade or business. He is generally spoken of as "retired" or "not in business." It is forcing the ordinary of words to say that conserving or enhancing one's estate is carrying on a trade or business. [ Higgins v. Commissioner, 111 F.2d 795-796 (2 Cir. 1940)]
The federal courts have consistently maintained the distinction between engaging in a trade or business and investing. Thus, in Whipple v. Commissioner, 373 U.S. 193, 83 S. Ct. 1168, 10 L. Ed. 2d 288 (1963), reh. den. 374 U.S. 858, 83 S. Ct. 1863, 10 L. Ed. 2d 1082 (1963), the court concluded that a taxpayer who held the controlling interest in several corporations and incurred a bad debt loss on loans he had made to certain of the corporations was entitled to only a nonbusiness bad debt deduction ...