Case Law Summaries

Reck v. Director, Division of Taxation

• Opinion Date: December 7, 2001
• Business Law
• E-Mail

TAXATION; PARTNERSHIPS; KEOGH ACT — Under the New Jersey Gross Income Act, a partnership may not deduct Keogh Plan distributions to partners as an expense of doing business.

This case dealt with “[t]he interesting and important question raised [as to] whether contributions made to a qualified retirement plan under the federal Keogh Act are deductible for purposes of New Jersey State Income Tax purposes.” The Gross Income Tax Act (GITA) “establishes a tax on New Jersey gross income reduced only by deductions, exemptions and credits expressly recognized by the Legislature.” Consequently, only the legislature can provide for exemptions and the exemptions must “be expressed in clear and unequivocal terms.” For business entities, such as partnerships, net income is determined after deducting “all costs and expenses incurred in the conduct” of the business. However, in New Jersey, “‘all costs and expenses’ are not deductible simply because the business incurred them. They must be ‘ordinary’ business expenses.” Under regulations promulgated by the Division of Taxation, contributions made by a partnership to a Keogh Plan on behalf of employees are deductible as ordinary and necessary business expenses. On the other hand, “[c]ontributions by the partnership to a Keogh Plan made on behalf of the partners are not a deductible business expense on the partnership return. Such Keogh contributions made by the partnership on behalf of the individual partners are taxable to [th]e individual partners for New Jersey gross income tax purposes.” The regulations further point out that amounts withdrawn from a Keogh Plan by partners are not subject to the GITA. Here, a partner of an accounting partnership argued that the regulations were unreasonable and that New Jersey should follow the federal Internal Revenue Code and allow partnerships to take deductions for contributions to Keogh Plans on behalf of their partners. The Court disagreed. It found that it was “reasonable for the Director [of the Division of Taxation] to conclude that contributions to Keogh Plans made on behalf of a partner constitute a portion of the partnership’s profits otherwise distributable to the individual partner and, thus, are not an ordinary business expense.” Case law had held that employer contributions to a Simplified Employee Pension Plan were not deductible from the employee’s gross income. Basically, the relevant New Jersey statute only permits deductions by businesses with 401(k) plans and the Court found that had the Legislature intended to allow for similar deductions for other forms of retirement plans, it could have done so. The Court pointed out that prior New Jersey cases supported the concept that not all items deductible for federal tax purposes are deductible for state tax purposes. In fact, one case said: “[t]he New Jersey gross income tax was conceived as a tax on gross income, not net. ... The legislative history of the Act reveals that the Legislature wished to limit deductions as a way of avoiding the tax shelters and ‘loopholes’ found in the federal tax laws.”

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