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, thereby receiving a cash benefit. 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, companies are required to capitalize all R&D costs and amortize these costs over either five years, for domestic R&D costs, or ten years, for foreign R&D costs. This is the result of IRC Sec. 174 which was implemented as part of the Tax Cuts and Jobs Act (TCJA). As of this date, New Jersey has not decoupled from this rule.

Many companies, especially those in the technology and pharmaceutical industries where significant R&D costs are incurred, may have significantly less losses available to sell in 2023. The ultimate result is lower proceeds from the New Jersey NOL sale which converts to a significant hit to a companies’ cash flow. 

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 Sec. 382. The provisions of IRC Sec. 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 Sec. 382, companies that have experienced an ownership change will have a limitation on their NOLs, some may be limited beyond the allowed 20-year carryover period and therefore deemed unusable or worthless. It is unclear how soon the New Jersey Economic Development Authority (NJEDA) and the New Jersey Department of Taxation will start scrutinizing these rules for companies selling NJ NOLs or R&D credits.

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

• Potential less benefit due to the R&D capitalization rules of IRC Sec. 174;
• Uncertainty and scrutiny around how NOL limitations due to ownership changes will affect the NJ NOL sale program; and
• The additional expense of an ownership change study (IRC Sec. 382 analysis) may now be necessary to sell a companies’ tax benefits.