Shechtel v. Dir., Div. of Taxation

Decision Date03 September 2020
Docket NumberDOCKET NO. A-0252-18T1
PartiesANDREW J. SHECHTEL, Plaintiff-Appellant/Cross-Respondent, v. DIRECTOR, DIVISION OF TAXATION, Defendant-Respondent/Cross-Appellant.
CourtNew Jersey Superior Court — Appellate Division

NOT FOR PUBLICATION WITHOUT THE APPROVAL OF THE APPELLATE DIVISION

This opinion shall not "constitute precedent or be binding upon any court." Although it is posted on the internet, this opinion is binding only on the parties in the case and its use in other cases is limited. R. 1:36-3.

Before Judges Rothstadt, Moynihan and Mitterhoff.

On appeal from the Tax Court of New Jersey, Docket No. 295-2017, whose opinion is reported at 31 N.J. Tax 89 (Tax 2018).

John Lindau Berger argued the cause for appellant/cross-respondent (Lowenstein Sandler, LLP, attorneys; John Lindau Berger, of counsel and on the briefs; Kenneth J. Slutsky, on the briefs).

Ramanjit K. Chawla, Deputy Attorney General, argued the cause for respondent/cross-appellant (Gurbir S. Grewal, Attorney General, attorney; Melissa H. Raksa, Assistant Attorney General, of counsel; Ramanjit K. Chawla, on the briefs).

PER CURIAM

In this appeal, we are asked to determine whether the Tax Court properly interpreted the New Jersey Gross Income Tax Act (Act), N.J.S.A. 54A:1-1 to 54A:10-12, when it held as a matter of law that defendant, the Director, Division of Taxation (Division), correctly determined that a taxpayer, plaintiff Andrew H. Shechtel, could not reduce his taxable distributive share of a partnership's income in 2010 by partnership losses incurred in 2009. According to Shechtel, his 2009 losses could not be applied in 2009 because they exceeded his "at risk" exposure in the specific partnership in 2009, but not in 2010.

The Division contended that the Act was not subject to the "at risk" limitation imposed under § 465 of the United States Internal Revenue Code (I.R.C.) that prevented the loss from being applied until the tax year in which the loss exceeded the partner's at risk amount. The Division maintained that Shechtel should have applied the loss in 2009 and when he failed to do so, he lost the deduction forever and could not recoup it by retroactively applying it to his 2009 income.

Shechtel pursued his claim in the Tax Court and on July 6, 2018, that court issued an order denying his motion for summary judgment, and granting the Division's cross-motion for the same relief, except as to the issue of the interest and penalties imposed by the Division to which it claimed it was entitled because of the improper application of the loss on Shechtel's 2010 return. In support of its order, the Tax Court issued a comprehensive opinion explaining why Shechtel incorrectly relied upon § 465 and therefore was not entitled to the deduction. See Shechtel v. Dir., Div. of Taxation, 31 N.J. Tax 89 (Tax 2018).

Thereafter, Shechtel appealed, arguing to us that the Tax Court incorrectly determined his liability as a matter of law. The Division cross-appealed from the Tax Court's determination that it was not entitled to interest or penalties.

We have carefully reviewed both parties' contentions in light of the undisputed facts and applicable principles of law. For the reasons that follow, we reverse the Tax Court's determination as to Shechtel's tax liability and affirm its determination as to interest and penalties.

I.

The salient facts are not disputed and were cogently described by the Tax Court in its opinion. For context, we repeat them here:

For tax years 2009 and 2010, [Shechtel] was a member of several entities which were taxed as partnerships.
One such entity was S&S Yield Company, L.L.C. ("SSY") in which plaintiff was a 99% member for tax years 2009 and 2010.
For tax year 2009, [Shechtel] received income from other partnerships totaling $16,858,589. His distributive share of loss from SSY was $14,915,338. Per [Shechtel], pursuant to I.R.C. § 465, he could only use $10,051,551 of this loss (to offset income received from other partnerships) because the total loss exceeded his at risk amount in SSY. The balance of $4,863,787 ($14,915,338 less $10,051,551) was federally disallowed and suspended until such time that he made up or increased his at risk amount in SSY. He therefore reported $6,807,037 (although $16,858,589 minus $10,051,551 equals $6,807,038) as his distributive share of net partnership income on his 2009 [Gross Income Tax (GIT)] return.
For tax year 2010, [Shechtel's] distributive share of passed-through income from other partnerships totaled $18,616,866. His distributive share of loss from SSY was $6,746,831. To this amount, he added the 2009 suspended loss of $4,863,787 (totaling $11,610,718). He then reported his net partnership income on the 2010 GIT return as $7,006,148 ($18,616,866 less $11,610,718). On the NJK-1 issued by SSY, a hand-written notation stated: "[t]here is an additional loss of 4863787 (sic) taken on this 2010 return. It was suspended in 2009 by 'at risk' rule, but allowed now."
[The Division] audited plaintiff's 2010 GIT return about three years after it was filed and denied $4,863,787 of the $11,610,718 claimed loss. It explained that the . . . Act "did not contain a provision for the carryback or carryforward of losses, nor does it recognize the Federal 'at risk' limitations for partnerships," as evidenced by N.J.A.C. 18:35-1.3(d),which requires "any and all" passed-through income/loss to be reported as a partner's distributive share. [The Division] concluded that the "federal suspended loss" for SSY should have been reported by [Shechtel] on his 2009 GIT return, and could not be "carried forward" to tax year 2010.
Due to the disallowance, plaintiff's 2010 reported income increased by $4,863,787, which in turn, increased the GIT due from the reported $622,330 to $1,058,611. [The Division] demanded the difference of $436,281, which with penalty and interest, totaled $540,107. This was despite the fact that for the 2009 tax year, plaintiff reported $1,525,453 as total tax paid (through withholdings and payments), and requested $903,123 (amount withheld/paid less reported GIT due $622,330) be used as a credit towards his 2011 GIT.
[Id. at 93-94.]

In rejecting Shechtel's contentions, the Tax Court first found that there was no basis for his argument that the suspension of his 2009 loss until 2010 was consistent with the Act's mandate that "[a] taxpayer's accounting method under this act shall be the same as his accounting method for Federal income tax purposes." Id. at 95 (quoting N.J.S.A. 54A:8-3(c)). According to the court, the I.R.C.'s limitation on a taxpayer's ability to recognize a partnership loss up to "the aggregate amount with respect to which the taxpayer is at risk . . . for such activity at the close of the taxable year," I.R.C. § 465(a)(1), and then apply any excess over the at risk amount to a subsequent year when the at risk amount wassufficient, under § 465(a)(2), was not a federal accounting method even though it was included within those sections of the I.R.C. commonly viewed as defining federal accounting methods. See Shechtel, 31 N.J. Tax at 98.

According to the Tax Court, § 465 was a legislative device to prevent tax shelters and based on its legislative history, was not an accounting method that was to be employed in the calculation of a taxpayer's income for New Jersey GIT purposes. Id. at 98-100. The court stated that,

the crux of I.R.C. § 465 is whether, and how much, is the at risk amount. The consequent suspension of the deductibility of amounts in excess of the at risk amount is dependent on when and how much of the at risk amount is restored, thus, not an attempt to match the loss incurred with the income earned in the same taxable year, the aim of an overall accounting method.
[Id. at 99-100 (footnote omitted).]

For that reason, the court concluded "that I.R.C. § 465, is a substantive provision, and not merely a timing statute. Therefore, it is not incorporated into N.J.S.A. 54A:8-3(c)." Id. at 100.

The court found support for its decision in N.J.S.A. 54A:5-2, which permits the application of losses that "occur within one category of gross income . . . against other sources of gross income within the same category of gross income during the taxable year." Quoting from Estate of Guzzardi v.Director, Division of Taxation, 15 N.J. Tax 395, 400 (Tax 1995), aff'd o.b., 16 N.J. Tax 374 (App. Div. 1996), the court stated "[t]his allowance of loss offset requires that the 'items of loss and gross income must occur during the same taxable year.'" Shechtel, 31 N.J. Tax at 101. According to the court, even if § 465 was a federal accounting method, it could not "'control the determination of . . . losses,' especially where N.J.S.A. 54A:5-2 does not incorporate nor reference 'federal accounting methods.'" Ibid. (quoting Guzzardi, 15 N.J. Tax at 404).

The Tax Court stated that "N.J.S.A. 54A:5-2 does not permit a carry-forward of the incurred and passed-through loss of a prior tax year," id. at 103, as the statute was not limited only to allowable loses under the I.R.C., "which [are] not useable solely because there is insufficient income in the same category to absorb such loss," id. at 104. The court concluded "that I.R.C. § 465 via application of N.J.S.A. 54A:8-3(c) does not render N.J.S.A. 54A:5-2 as either inapplicable or as non-controlling," and Shechtel's arguments that he be

allowed a carry forward of the federally disallowed loss until such time he increases his at risk amount (which could be as here, one year, or for an indefinite period as recognized by I.R.C. § 465) . . . would not only render the loss carry-forward prohibition of N.J.S.A. 54A:5-2 redundant, but would also require that all other anti-shelter provisions . . . also be deemed immune to the application of N.J.S.A. 54A:5-2.
[Shechtel, 31 N.J. Tax at 105-06.]

The Tax Court then explained why Shechtel was time barred from recovering the excess GIT he paid in 2009 that was due to his following §...

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