NJ IRC Section 965 Potential Refund Opportunity
August 16, 2021
By William Gentilesco and Gary Bingel
This article was update on December 29, 2021, to reflect recent legislative changes.
If you paid New Jersey Gross Income Tax on IRC Section 965 income in 2017 you have until April 1, 2022, to claim a refund.
IRC Section 965 Income
The Tax Cuts and Jobs Act created a one-time repatriation, or what many call “transition,” tax under Section 965 of the Internal Revenue Code (“§965”) as it relates to the accumulated profits in any specified foreign corporation (“SFC”). This forced many U.S. shareholders of an SFC to include their share of the untaxed accumulated profits as a deemed dividend on their federal and corporate income tax returns. This raised an issue regarding the treatment of §965 deemed dividends for state income tax purposes.
New Jersey Guidance
On March 16, 2018, the New Jersey Division of Taxation (“Division”) issued guidance on the treatment of IRC §965 income. With respect to the New Jersey Gross Income Tax, the Division advised that: “Dividends are an enumerated category of income. Therefore, deemed repatriation dividends reported under IRC §965 must be included in New Jersey gross income in the same tax year and in the same amount as reported for federal purposes.” As such, the Division’s position is that deemed dividends under IRC §965 are taxable for New Jersey Gross Income Tax purposes in cases where an individual taxpayer holds stock in an SFC directly or through a partnership or an S corporation that owns SFC stock. As explained below, there is a position that the Division's guidance is incorrect.
While dividends are an enumerated category of income, the Gross Income Tax Act [N.J.S.A. §54A:5-1(f)] defines dividends as “any distribution in cash or property made by a corporation …” IRC §965 deemed dividends are not paid in cash or property; that is why they are referred to as deemed dividends. For this reason, many taxpayers excluded IRC §965 income from their 2017 New Jersey Gross Income Tax Returns.
The Division has been auditing those tax returns, adding back the income and issuing assessments. Importantly, the Division’s assessments are not final because taxpayers can and have been appealing their assessments both administratively and, in some cases, with the New Jersey Tax Court. Thus, it may be a while before there is a final disposition of this issue. Until then, it is likely that the Division will disallow IRC §965 refund claims. In such cases, taxpayers will need to protest their disallowed refunds in accordance with procedural rules.
As the amounts paid in tax related to these deemed dividends are often significant, the cost to file a New Jersey refund claim and any related protest and/or court appeal is likely minimal compared to the potential refund. The fact that other taxpayers are further along in their IRC §965 disputes with New Jersey may minimize costs for subsequent refund seekers.
Taxpayers that paid New Jersey Gross Income Tax on IRC §965 deemed dividends should consider filing a refund claim with the state before the statute of limitations expires in order to preserve their rights. Normally, a taxpayer has three-years to file a refund claim. However, due to COVID-19, the deadline to claim a refund was extended by the governor until April 1, 2022.