Pitfalls of Selling New Jersey Net Operating Losses in 2023

Loss companies that participate in the New Jersey Technology Business Tax Certificate Program may benefit by selling their net operating losses (NOLs) and research and development (R&D) credits that may not be realizable in the near future and in return receive a cash benefit currently. However, there are two recent legislative changes that may affect how much benefit a company can receive from the program.

Capitalized R&D Costs

Beginning in 2022, for federal income tax purposes companies are required to capitalize all R&D costs and amortize these costs over either five years, for domestic R&D costs, or fifteen years, for foreign R&D costs. This is the result of Internal Revenue Code (IRC) Section 174, which was implemented as part of the Tax Cuts and Jobs Act (TCJA). Many companies, especially those in the technology and pharmaceutical industries where significant R&D costs are incurred, may have significantly less losses (or taxable income) in 2023.

New Jersey has recognized the effect the federal R&D capitalization rules will have on companies and on July 3, 2023, passed legislation that decouples the state from the federal law. As part of the New Jersey budget, for tax years beginning on or after January 1, 2022 New Jersey will allow a deduction for research and experimental expenditures during the same tax year for which a New Jersey research and development credit is claimed, notwithstanding the timing schedule required by the federal rules. But be aware: The NJ Division of Taxation has interpreted this guidance as limiting the NJ deduction to the value of the New Jersey qualified research expenditures only. 

If a company has already filed a 2022 New Jersey tax return with the R&D cost capitalized, an amended return may be filed to claim the deduction for these expenses pursuant to the new law.

Limitations Due to Changes in Ownership

For tax years beginning on or after January 1, 2020, New Jersey has adopted the federal ownership change rules governed by IRC Section 382. The provisions of Section 382 limit the use of NOLs if a company has incurred a greater than 50% change in ownership over a three-year period.  Prior to January 1, 2020 New Jersey had decoupled from this code section.  Now that New Jersey has adopted the rules of IRC Section 382, companies that have experienced an ownership change could have a limitation on their NOLs, and therefore not be able to sell all of the NJ NOL or R&D credits generated but rather just a small portion. Some companies may have a significant limitation that may deemed the NJ NOL or R&D credits unusable or worthless. It is only a matter of time until the New Jersey Economic Development Authority (NJEDA) and the New Jersey Department of Taxation will start scrutinizing these rules or redesign their application forms to account for these changes. 

In summary, the pitfalls of the 2023 Technology Business Tax Certificate Program are as follows:

• If the 2022 New Jersey tax return has been filed with the R&D costs capitalized, an amended return may be needed to claim the deduction up to the value of the NJ qualified research expenditures;
• Uncertainty and scrutiny around how NOL limitations due to ownership changes will affect the NJ NOL sale program; and
• The additional expense of an IRC Section 382 analysis (ownership change study) may now be necessary to establish the amount of NOLs and R&D credits a company has available to sell.