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Tax Law

Saving “At Risk” Losses – New Jersey Superior Court Holds Individual Allowed to Carry Forward Losses From Partnership

The New Jersey Superior Court reversed the New Jersey Tax Court and held that an individual taxpayer was permitted to carry forward losses from a partnership incurred in 2009 to reduce the individual’s distributive share of the partnership’s income in 2010.  The Court explained that, pursuant to IRC § 465, a partner in a partnership may not apply a loss to reduce his distributive share of partnership income when the loss exceeds the partner’s “at risk” exposure in the partnership at the close of the taxable year; and that the loss is not recognizable until the year in which the at risk amount exceeds the loss.  The Court determined that IRC § 465 is a federal method of accounting, and that under the New Jersey Gross Income Tax Act, a taxpayer’s method of accounting for New Jersey Gross Income Tax (“GIT”) purposes must be the same as his accounting method for Federal income tax purposes.  Thus, the Court concluded that the taxpayer property calculated his 2009 GIT liability by not including the amount of a loss that exceeded his at risk exposure in a partnership, and correctly applied the loss in 2010 when his at risk amount exceeded the loss.  The Court also noted that, even if it were to affirm the Tax Court’s decision, the taxpayer should have been allowed to recoup the lost deduction under the “square corners” doctrine.  The Court stated that it is “fundamentally unfair” for the Division of Taxation “to announce in its official publication that, under a certain set of facts, federal methods of accounting will be applied,” and then “retroactively apply a different standard years later.”  Shechtel v. Dir. Div. of Tax, Case No. A-0252-17T1 (N.J. Super. Ct. App. Div. Sept. 3, 2020).