Mistakes happen, and taxes are not exempt. From time to time, taxpayers make typos, misinterpret information, or simply misread instructions. When this happens, the IRS generally sends some sort of notice indicating the extent of an issue, alerting the taxpayer as to the problem and proposing an alternate settlement, whether resulting in additional money owed by the taxpayer — or a larger refund from the IRS. When this happens, it is not necessary for taxpayers to file an amended federal return, but the same isn’t always true on the state side. In New Jersey, taxpayers must pay close attention to the rules to ensure proper reporting is maintained on the state level.
If the Taxpayer Doesn’t Succeed, the IRS Surely Will
As a baseline, all changes enacted on a federal level, like an updated gross income amount or any new details included in an amended return, need to be communicated to the state of New Jersey as well. However, if you don’t do this on your own, the IRS surely will. The federal government and New Jersey are both part of the Governmental Liaison Data Exchange Program, or GLEDP, a partnership between federal, state, and local taxing authorities that assists with voluntary tax law compliance. Items shared include employment tax information, audit results, and the details shared on federal personal and business income tax returns.
The IRS executed an MOU, or memorandum of understanding, with the state of New Jersey, a reciprocal agreement that means that New Jersey shares information with the IRS while the IRS also shares information with New Jersey. Information can be shared relatively freely, but only if used for tax purposes; sharing personal data just for the fun of it does not fall under the purview of the IRS. For this reason, New Jersey will find out when federal income changes. However, taxpayers must still notify the state, and filing an amended return is often suggested to avoid penalties that may accrue for failing to do so.
Notice of Change in New Jersey
If the IRS comes knocking, a federal examination isn’t the only thing taxpayers have to worry about. The state of New Jersey is also interested in what, if anything, may arise over the course of an audit. Once things wrap up, it’s the taxpayer’s responsibility to notify the New Jersey Division of Taxation of any changes that may have occurred. And, unless there is a clear and easily proven cause, failing to meet deadlines here may result in harsh fees and penalties. These include:
- Late filing penalties of $100 per month delayed, as well as 5% of the amount of the underpayment each month, not to exceed 25% of the total amount
- Late payment penalties of 5% of the total tax due
- Civil fraud penalties, if deemed to be appropriate, of 50% of the underpayment penalties
- Interest at a prime rate plus 3% of the total tax due each month
Under New Jersey’s revenue statutes, changes reported must include updates to federal income, correction of a federal return that may change New Jersey taxable income, and any adjustments to the federal EIC that may affect New Jersey’s EIC. This change must be presented within 90 days, and can be satisfactorily submitted by an amended state tax return. Taxpayers with no material changes that will affect New Jersey liability question whether this policy applies, but it’s still important for taxpayers to follow the letter of the law, even if not the spirit. In these cases, it’s still recommended to submit a notice of federal change to outline what changed and how it changed.
The receipt of an IRS Final Determination Notice starts the 90-day clock in New Jersey, but it’s also the mechanism through which the periods of limitation to make both a deficiency assessment or a claim for refund can be extended for an additional four years. Note that this isn’t a given; the period of limitation is only extended when a notice of federal change is filed as a result of an audit. This extension isn’t uniform for individuals and corporations, either. The filing of a notice of federal change kicks off the period of limitations for individuals, as the applicable statute states that if an individual does not report a change or correction as required, the Division can determine the amount of tax at any time. This means that upon the filing of a notice, New Jersey can commence an audit, even if the original period of limitation had passed. For corporate taxpayers, on the other hand, a notice of federal change filed in a timely manner is required to extend the statute of limitations on refund claims.
With the critical nature of a notice of federal change, it’s important to define exactly what this means. A notice of federal change is defined as a tax return that is submitted within the 90-day deadline. For those hoping to process refund claims, this is critical to keep in mind, as statutory limitations periods must be firmly enforced in refund cases. Corporate taxpayers who do not promptly file within the strict time limits provided may find themselves out of luck and unable to claim a refund otherwise eligible — and in cases where large amounts of money are involved, this can be particularly painful. Think there’s wiggle room? There isn’t. In Lenox Inc. v. Dir., Div. of Taxation, New Jersey found that the taxpayer in question was eligible to take more losses than were originally claimed, leading to a sizable refund. The taxpayer filed the refund claim but was denied because his notice of federal change was received just one day late, thus eliminating the right to an extended statute of limitations.
A notice of federal change isn’t necessarily the be all, end all, either. Through this vehicle, taxpayers have the opportunity to actually challenge the IRS determination made within. Further, New Jersey may also conduct a separate examination in some circumstances, leading to a potentially different conclusion than that of the IRS. In fact, it has even been demonstrated in Tax Court that New Jersey is not bound by the IRS’ findings; in Booth v. Director, Division of Taxation, a taxpayer asserted that the Division of Taxation should have to abide by the IRS’ findings, in this case regarding the marital status of a decedent upon death, but the court found that New Jersey was free to operate independently if necessary. However, there are limitations on the state’s ability to reject IRS findings. In Infosys Limited of India Inc. v. Director, Division of Taxation, the court found that it was not appropriate for New Jersey to levy tax on the taxpayer’s foreign source income if not included by the IRS for federal tax purposes. In this particular case, the IRS excluded the foreign source income because of a treaty benefit, but New Jersey argued that it should be taxed. However, due to the fact that New Jersey has no addback rules on the books regarding foreign source income of this nature, the court determined that the starting base for computing net income in New Jersey is federal taxable income — a fact that isn’t up for debate without an alternate rule in place.
Special Rules for Offshore Disclosures
The added challenges of offshore disclosures arise yet again in the case of notification of federal changes in New Jersey. This is a major exception in standard policies; taxpayers entering into an Offshore Voluntary Disclosure Program (OVDP) should not follow the same notification rules as in normal circumstances. While a notice is adequate to inform the Division of any changes to taxable income, it isn’t enough to avoid criminal prosecution if that is a possibility. Instead, taxpayers in this situation should make use of the New Jersey Offshore Voluntary Compliance Initiative (NJOVCI). NJOVCI is essentially a parallel of the federal program and is actually required for those New Jersey taxpayers enrolled in an OVDP. With a similar function, NJOVCI exists to help taxpayers make a deal while attempting to settle potential challenges or errors in offshore reporting. Within this program, taxpayers are offered the opportunity to make a deal, which generally ends up involving a 5% late payment penalty and an additional 5% amnesty penalty. In exchange, the state agrees not to collect the higher 50% civil penalties and to not submit the taxpayer for criminal prosecution.
Making a NJOVCI submission isn’t the kind of thing that can be done under the table; the Division of Taxation must be informed of federal OVDP enrollment and all IRS documents as well as the program acceptance letter must be made available. However, as these forms aren’t available until the satisfactory completion of the OVDP, it’s still in a taxpayer’s best interest to enroll as soon as possible, even if the federal program is still ongoing. If taxpayers wait, it is possible that the state taxing authority may discover the violations before there is time to make amends.
Other Voluntary Disclosures
While NJOVCI has its merits, it’s not an option for anyone not participating in an OVDP and there are no parallel programs for domestic voluntary disclosures or non-willful failures to disclose. However, there are two additional programs available in New Jersey for both individuals and corporations.
The pathway for individuals can be used by both residents and nonresidents of New Jersey to disclose income tax previously unreported who are not under criminal investigation, state audit, or have filed an amended return for the year in question. Disclosure can begin as soon as participation is verified, and entails a written Voluntary Disclosure Agreement, a statement of the applicable tax years, and the reasons for not filing. A confirmation letter will be sent to the taxpayer. If a VDA is requested anonymously, the taxpayer will have to provide a name, social security number, and address after receiving the confirmation. Then, an agreement will be sent to the taxpayer to be signed. Unlike NJOVCI, no 5% late penalty will be charged for any of the tax years covered by the disclosure program, but the 5% amnesty penalty will still apply, plus interest.
For corporate taxpayers, the options are a little bit different. Eligible businesses are required to submit a VDA Fact Pattern Form, which covers all New Jersey business activities, in conjunction with a written request for a VDA. This information package must include:
- The date business transactions began in New Jersey and the registration status for taxes in New Jersey
- Any activities that exceeded the solicitation of sales standard of Pub. Law 86- 272
- The type of taxes to be filed and paid
- A statement confirming that the company is not under audit or involved in any criminal investigations
- The end date of the accounting year
- Contact information for corporate representatives
VDAs are not an option if returns were previously filed for the type of tax at hand, or if a disclosure was already completed for another form of omitted tax. For the former situation, an amended return with a penalty abatement request is the best option; for the latter, a Closing Agreement to determine a settlement amount is recommended. New Jersey domestic corporations are not eligible for VDAs as they are already registered for CBT, but are encouraged to contact the Division of Taxation to discuss alternatives.
Bridging the Gap Between State and Federal
Nothing in tax can ever be easy, and that includes the effort required to reconcile federal and state tax issues. While New Jersey makes an effort through its disclosure programs, taxpayers with even simple problems will still end up jumping through hoops to satisfy the Division of Taxation, and relatively steep penalties may still apply. While to err is human, the fewer errors that can go into a federal return, the better. After all, one small ripple in the federal tax system can evolve into a tsunami on the state level.