You Had Your Chance: New Jersey Tax Court Prohibits Audit Adjustments to Closed Years

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The New Jersey Tax Court held that the Division of Taxation (“Taxation”) cannot assess tax in years open under the statute of limitations if the tax is attributable to the elimination of net operating loss (“NOL”) carryforwards from years that are closed under the statute of limitations. R.O.P. Aviation, Inc. v. Dir., Div. of Tax’n, No. 001323‑2018, 2021 N.J. Tax LEXIS 8 (N.J. Tax Ct. May 27, 2021). The decision is significant because it prohibits an audit strategy many states use that effectively operates as an end-run around statutes of limitation.

Facts: R.O.P. Aviation, Inc. (“Aviation”) is engaged in the business of leasing aircraft to unrelated parties and affiliates. For tax years 2007 through 2011 (the “Closed Years”), Aviation’s corporation business tax (“CBT”) returns were accepted as filed and not audited. The returns for the Closed Years reported approximately $18.5 million in NOLs available for carryforward. Id. at *1-*4.

Taxation conducted an audit of Aviation’s CBT returns for the tax years 2012 through 2015 (the “Open Years”). During the audit, Taxation eliminated Aviation’s NOL carryforwards from the Closed Years, claiming that certain intercompany leases were not arm’s-length, and that Aviation should have reported a larger profit in the Closed Years. By increasing income in the Closed Years and eliminating NOL carryforwards, income in the Open Years also increased, resulting in the assessment for the Open Years. Aviation argued that Taxation’s adjustments to the Closed Years were barred under the statute of limitations. Id.

The Decision: The tax court first held that the statute of limitations to conduct an audit is subject to the same statute of limitations applicable to tax assessments, which is four years from the date the return is filed (absent any allowable extensions). Id. at *13. Even though the statute does not expressly impose a time limit for Taxation to conduct an audit, the tax court reasoned that because an assessment flows from an audit, the audit must be conducted in the same period within which an assessment must be made. The court noted that permitting an adjustment of the NOL in the Closed Years would be an indirect assessment of tax, and would result in Taxation “doing indirectly what the statute does not permit directly: bypassing the four-year statute of limitations.” Id. at *16. Because the parties agreed that the Closed Years were not open to assessment under the four-year statute of limitations, the tax court held that the elimination of the NOLs in the Closed Years was untimely.

The tax court also held that Taxation could not use its powers to adjust intercompany transactions to audit the Closed Years and eliminate the NOLs. Id. at *20. Although the tax court recognized Taxation’s broad powers to audit and adjust intercompany transactions, it nonetheless held that this authority cannot be construed to defeat the four-year statute of limitations for assessment. Id. at *18.

Finally, the tax court refused to follow IRS audit procedures, which both parties agreed would allow the IRS to adjust NOLs in closed years and assess tax in an open year. The court reasoned that it was not bound by IRS audit procedures or the IRS’s interpretation of its own authority, and was firm in its construction of New Jersey law: “[i]f [the] audit is untimely, the NOL cannot be revised.” Id. at *23.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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