On appeal from the Tax Court of New Jersey whose decision is reported at 14 N.J. Tax 501 (1995).
Approved for Publication December 27, 1996. As Corrected March 5, 1997.
Before Judges King, Keefe and Conley. The opinion of the court was delivered by Conley, J.A.D.
The opinion of the court was delivered by: Conley
The opinion of the court was delivered by
The State appeals paragraphs one and three of a Tax Court declaratory judgment entered March 10, 1995 and based upon a written opinion reported at 14 N.J. Tax 501 (Tax 1995) construing the "standard for deductibility" under N.J.S.A. 54A:5-1b for determining net partnership income. We reverse and remand.
Paragraph one of the order declares that "the standard for deductibility of a partnership expense is the standard set out in N.J.S.A. 54A:5-1b; that is, whether the expense was paid or incurred in the course of the business, profession or other activity of the partnership" and paragraph three declares "example 7 of [N.J.A.C. 18:35-1.14(c)(8)] is void and of no further force and effect." *fn1 Pertinent to the issues before us, the disputes between the Director of the Division of Taxation (Director) and the taxpayer arise in the context of the taxpayer's 1985 New Jersey gross income tax return which included a calculation of net income received by the taxpayer from his partnership. In that calculation, the taxpayer had deducted his proportionate share of certain contributions made by the partnership to various organizations and reported by the partnership for federal tax purposes as a § 170 expense. *fn2 There is no dispute that the taxpayer took that deduction on his individual federal tax return. There is also no dispute that the New Jersey gross income tax law does not permit a separate deduction for charitable contributions. Nonetheless, the taxpayer asserted that in fact his proportionate share of the partnership contribution should be deducted from his partnership income in arriving at his net income therefrom pursuant to N.J.S.A. 54A:5-1b.
N.J.S.A. 54A:5-1b refers to the net income from the operation of a business "after provision for all costs and expenses incurred in the conduct thereof. . . ." Based upon its existing regulation and "long-standing" practice, the Director rejected the taxpayer's position. In this respect, N.J.A.C. 18:35-1.14(c)(3) requires partnerships to determine their net profits "in the same manner an individual taxpayer determines his or her 'net profits from business' pursuant to N.J.A.C. 18:35-1.25. . . ." N.J.A.C. 18:35-1.25(c) provides that "no deduction shall be allowed for any expense or loss which is not incurred in the ordinary course of the conduct of the taxpayer's trade or business." (Emphasis added). Thus, in his final determination of December 15, 1992, the Director concluded that the contributions here, reported by the partnership for federal purposes as § 170 charitable contributions and not as ordinary business expenses under Internal Revenue Code § 162 (26 U.S.C.A. § 162, hereinafter referred to as § 162), *fn3 were not deductible ordinary business expenses.
Moreover, because the expenses were reported for federal purposes as other than ordinary business expenses, that is as § 170 charitable contributions, the Director rejected the taxpayer's efforts to demonstrate that such contributions, in fact, were ordinary business expenses. See A.P. Smith Mfg. Co. v. Barlow, 13 N.J. 145, 154, 98 A.2d 581 (1953) ("modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities within which they operate. . . . Incidental to their proper objects and in aid of the public welfare [is] the power of corporations to contribute corporate funds . . . in support of academic institutions. . . . Such expenditures may . . . be justified as being for the benefit of the corporation; indeed . . . the matter may be viewed strictly in terms of actual survival of the corporation in a free enterprise system."). The Director, thus, issued a final determination assessing a tax deficiency assessment. *fn4
Ultimately, after the taxpayer had filed a complaint with the Tax Court challenging the assessment, the Director withdrew the final determination. In addition, amendments to the critical regulations were proposed. Notice of these amendments was published in 47 N.J.R. 475-479 (February 6, 1995). *fn5
Although the dispute over the particular deductions involved in the deficiency determination as to the taxpayer's 1985 return was, thereby, rendered moot, the Tax Court determined that both the "taxpayers and the Director continue to have 'genuine' disagreement regarding taxpayers' reporting responsibilities under N.J.S.A. 54A:5-1 [et seq.] and the Director's regulations . . . as to the contributions." 14 N.J. Tax at 512. Because we believe the Tax Court erred substantively, we do not address whether it should have simply dismissed the complaint as moot. Our silence on this issue, however, does not necessarily reflect agreement with the Tax Court's denial of the Director's motion to dismiss on this ground.
Critical to the issues before us, the dispute that the Tax Court deemed appropriate for declaratory judgment concerned "the standard for deductibility" under N.J.S.A. 54A:5-1b for the purposes of determining reportable net income from a business. In particular, and as phrased by the Tax Court: "must taxpayers demonstrate that the contributions were 'ordinary and necessary' expenses of the partnership's business, or merely that they were 'incurred in the conduct of the partnership's business'?" *fn6 14 N.J. Tax at 512.
N.J.S.A. 54A:5-1b defines net profits from business as:
net income from the operation of a business, profession, or other activity after provision for all costs and expenses incurred in the conduct thereof, determined either on a cash or accrual basis in accordance with the method ...