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Miller v. Director

June 17, 2002


On appeal from the Tax Court of New Jersey, Docket No. 004040-2000.

Before Judges Braithwaite, Coburn and Weissbard.

The opinion of the court was delivered by: Coburn, J.A.D.


Argued June 3, 2002

This appeal concerns the taxation of a shareholder of a Subchapter S corporation under the New Jersey Gross Income Tax Act, N.J.S.A. 54A:1-1 to 10-12 (the "Act"). It arose from two related transactions. In the first transaction, plaintiff George K. Miller, *fn1 the corporation's principal shareholder, had the corporation sell virtually all its assets to a third party for cash. In the second transaction, which occurred in the same tax year, Miller liquidated his stock in the corporation for the cash generated by the asset sale plus the balance of the corporation's ordinary income. He treated the two transactions as if they were one, reporting what he calculated as his gain under the general provision of N.J.S.A. 54A:5-1(c) concerned with net gains from disposition of property. Miller followed that course to avoid a tax on the return of capital.

The Director of the Division of Taxation issued a deficiency notice based on a literal application of the language used in the Act. He determined that the cash generated by the first transaction had to be reported as Miller's net pro rata share of Subchapter S corporation income under N.J.S.A. 54A:5-1(p). The Director's re-categorization of that income substantially increased Miller's basis in his stock; as a result, the Director determined with respect to the second transaction that Miller was entitled to report a loss under the portion of Subsection 5- 1(c) specifically governing the sale of Subchapter S corporation stock. The Director's literal interpretation of the Act created an increased tax assessment, including interest, of $89,708.

Plaintiffs sued the Director in the Tax Court, contending that his calculation improperly taxed a return on capital. Both sides moved for summary judgment. The Tax Court agreed with plaintiffs in a reported opinion, Miller v. Director, Div. of Taxation, 19 N.J. Tax 522 (Tax 2001), and the Director appealed.

Although we concur, based on this record, in the Tax Court's rejection of the Director's interpretation of the Act, we disagree with its solution. At oral argument, we suggested an alternative interpretation of the Act; namely, treating the two transactions as one involving a sale of stock under that portion of N.J.S.A. 54A:5-1(c) specifically addressed to Subchapter S corporations. Plaintiffs adopted our proposal as a reasonable alternative, if their own approach was rejected. The Deputy Attorney General took the position that although our proposal seemed to have merit, it might also create problems because of the Act's intricate provisions for taxation in this context.

We have always recognized that the Director's interpretation of specialized and complex tax provisions "is entitled to great respect by the courts." Metromedia Inc. v. Director, Div. of Taxation, 97 N.J. 313, 327 (1984) (citations omitted). On the other hand, we also generally defer to the Tax Court's expertise. See, e.g., Little Egg Harbor Tp. v. Bonsangue, 316 N.J. Super. 271, 285 (App. Div. 1998). Since on this record, we reject the resolutions of this case by the Director and the Tax Court, and since the issue we raised had not been briefed, and since its resolution might benefit from further development of the relevant facts and further analysis by the Director, we reverse and remand for further proceedings in the Tax Court.

I The facts are not in dispute. Miller was the principal shareholder of Shore Cable Company of New Jersey, Inc. ("Shore Cable"), a federal and New Jersey Subchapter S corporation. In 1996, Miller had Shore Cable sell virtually all its assets to Lenfest Atlantic, Inc., ("Lenfest"), for approximately $5 million. In the same year, Shore Cable paid a liquidating dividend to Miller that included the proceeds of the sale to Lenfest plus what the Tax Court conceded was "ordinary income from the operations of Shore Cable . . . totaling $6,969." Id. at 525. On the New Jersey Schedule K-1, which provides only one line for reporting Subchapter S corporation income, the liquidating distribution income allocated to Miller was $5,279,458. According to the Director, Miller's total Subchapter S corporation income was $5,375,730, reportable and taxable under Subsection 5-1(p) of the Act. However, Miller did not report the cash under that subsection.

Miller's approach, discernable from his New Jersey Schedule B Statement, entitled "Income from Disposition of Property," and concerned with the reporting of income under Subsection 5-1(c) of the Act, was to list his liquidating dividend from the sale of his stock as $5,060,810, a figure taken from line 20 of his federal Schedule K-1, which reported property distribution resulting from the Shore Cable stock sale. From that he deducted a "cost" of $565,802, which was his basis in the stock for federal purposes, and accordingly stated a net gain of $4,495,008. He listed, as well, a number of other personal capital transactions, most yielding losses, and concluded on Schedule B that his net income from disposition of property was $4,335,811. Ultimately, he adjusted this figure, in a manner that is not in dispute, to $4,341,291, which he reported as his gain under Subsection 5-1(c).

In his "NOTICE OF DEFICIENCY," the Director adjusted Miller's return by eliminating the Subsection 5-1(c) gain and adding an assessment under Subsection 5-1(p) of $5,375,730 for net pro rata Subchapter S corporation income, thereby creating the justification for most of the additional taxes claimed to be due. The Director explained his result, in part, by first calculating the consequences of Miller's sale of his stock. As to Miller's New Jersey basis in the stock, the Director provided the following figures:

Balance New Jersey AAA-Worksheet C -------------- $4,814,803 Capital Stock ---------------- 20,000 Paid in Additional Capital --- 1,132,639 Loans from Shareholders ------ 407,294 Prior year's unused losses --- 183,930 Total NJ Adjusted Basis ------- 6,558,666 He then calculated Miller's loss on the sale of the stock as follows:

Liquidating Distribution - Per NJ K-1 --------------- 5,279,458 Less: New Jersey Adjusted Basis (See above) -------------- (6,558,666) Loss on Disposition of Stock -------------------- (1,279,208) The Director then turned to the subject of Miller's gains and losses from the disposition of property. He listed the gains and losses as reported by Miller with one major exception: in lieu of the gain of $4,495,008 reported by Miller on the sale of the Shore Cable stock, the Director listed a ...

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