BY RICHARD LICHTIG CPA
PARTNER

The New Jersey Business Tax Reform Act, enacted in 2002, contained many provisions that were intended to close what the legislature perceived as "loopholes." Other provisions were unabashedly referred to as revenue enhancers. One such revenue enhancer was to deny a deduction for net operating losses (NOLs) on business tax returns for tax years beginning in 2002 and 2003. The inability to deduct NOLs was offset by the State extending the NOL carryover period by an additional two years.

At first blush it may sound as though the 2002 Act denied a deduction for NOLs bought under legislation that was enacted in 1997. (The 1997 law allows "qualified technology companies" to sell NOLs and unused research and development credits to unaffiliated buyers.) This is NOT the case! Qualified sellers and interested buyers can still engage in these transactions.

However, in order to take advantage of these tax benefits a seller's application must be received by the New Jersey Economic Development Authority (NJEDA) no later than June 30. The balance of this discussion describes what this means to potential sellers and buyers and whether or not it makes economic sense to submit an application.

This matter is particularly relevant for the State's once high-flying technology industry, as many of these companies have had a series of ups and downs in this turbulent economy. Notwithstanding excellent technology and products, some technology companies are experiencing a cash short fall because of either a drop off in sales or a more difficult environment in raising investor capital. One way to obtain additional capital is to take advantage of legislation that was intended for just that purpose, i.e., for profitable companies to provide cash-starved technology companies with needed capital so that the technology company can expand its New Jersey operations.

WHO QUALIFIES AS AN ELIGIBLE TECHNOLOGY COMPANY?
A seller of NOLs or unused research and development tax credits must be a qualified technology (or biotechnology) company. In order to be classified as such, a company must meet certain conditions. The business must:

• maintain its headquarters or have a base of operations within New Jersey,
• employ a total of not more than 225 people, 75% of whom must be based in New Jersey,
• employ "some combination" of "highly educated and/or trained" persons within New Jersey who use "sophisticated scientific research" equipment, processes, or knowledge to discover, develop, test, transfer, or manufacture a product or service.

WHAT ARE THE BENEFITS TO THE SELLER OF THESE TAX BENEFITS?
A seller of tax benefits obtains cash needed to operate its New Jersey business activities. The sales price must be at least 75% of the value of the forgone tax benefits.

Example 1 — A qualified technology company has $20 million of NOLs for which it may not get a tax benefit until several years down the road (if at all in light of the uncertainty of it ever being profitable). The company, a C corporation, conducts all of its business in New Jersey. If the company decides to sell its NOL to an unaffiliated buyer, the sales price must equal or exceed $1,350,000 [determined by multiplying the NOL ($20 million) by the tax rate (9%) and the statutory percent (75%)]. [Note: In order to meet the 75% test, sellers and buyers cannot take into account any present value concepts or their respective federal income tax considerations.]

WHAT ARE SOME OF THE OBLIGATIONS OF A SELLER?
In order to be a seller, a business must apply to the NJEDA to demonstrate its eligibility. As part of the application process, the seller must demonstrate to the NJEDA's satisfaction that it will use the sales proceeds to fund expenses in connection with the operation of the qualifying business. These expenditures could be in the form of additional equipment (including real estate), working capital, salaries, additional research activities, etc., all within New Jersey.

In addition, in order to keep the sales proceeds, a seller must attest that it will not relocate its headquarters or base of operations, as the case may be, out of New Jersey for at least the calendar year following the year in which the application was signed.

ARE THERE ANY OBLIGATIONS ASSUMED BY A BUYER?
Although a buyer does not take on any obligations, by the very nature of it wanting to be a buyer, it is likely that it will maintain or expand its present business operations within New Jersey, or, if it wasn't already located in New Jersey, move into the State. This, of course, enables New Jersey to increase its tax base by attracting profitable (i.e., taxpaying) businesses, as well as by increasing employment and capital spending. Moreover, buyers can be any business and any size, from a local operation to a company listed in the Fortune 500.

WHAT TAX PLANNING STRATEGIES MAY BE AVAILABLE?
NOL PLANNING — As mentioned above, the minimum price for which the tax benefits must be sold is the value of the benefits to the seller multiplied by 75%. The minimum selling price for a business that apportions its profits within and without New Jersey will therefore be less. (This is because the New Jersey state tax benefit, or value, that such a company would enjoy would be less.)

Example 2 — Assume the same facts as in Example 1, except that the average of the company's property, sales, and payroll (often referred to as the "apportionment percentage") was 40%. The minimum sales price would be $540,000.

Buyers can get an immediate cash benefit by reducing their next estimated tax payment by the full benefit bought (i.e., not just the amount paid).

Example 3 — Say the seller in Example 2 locates a buyer and the parties agree that on May 31 the buyer will pay 80% of the value of the loss (the buyer has thus agreed to pay $576,000). The buyer's June 15 estimated tax payment will be reduced by $720,000. [Note: The Alternative Minimum Assessment (or AMA) was enacted as part of the New Jersey Business Tax Reform Act. The AMA must be taken into consideration in determining the amount and timing of any tax savings. The AMA is beyond the scope of this discussion.]

RESEARCH & DEVELOPMENT CREDIT PLANNING — The New Jersey R&D credit is limited to 50% of a company's income tax liability. Some companies generate more credits than they can use in any given year and may not get the benefit of carry forwards if they anticipate generating additional "excess credits" year in-year out. These companies, even though profitable, are potential sellers of their R&D credits. [Note: this would hold true even if the selling company is a separate subsidiary of a large, multi-national parent company (see comment below regarding determinations on a separate company basis).]

OTHER CONSIDERATIONS
Taxpayers can apply to sell their losses from earlier years, too. Companies having losses that may soon expire (e.g., 1995 losses will expire in 2004) may want to sell those losses before they have no value whatsoever. [Note: Losses that are sold do not get a new "life" (i.e., they expire at the same time as they would have had there been no sale).]

The buyer gets "audit-free" losses. Any additional New Jersey income tax that results from an audit of the loss company's tax return will be borne by the seller (regardless of whether the adjustment is the result of an audit by the IRS or New Jersey).

The buyer gets a "certificate" from the State that confirms its eligibility to claim the tax benefit of the loss or credit.

Eligibility for being a "qualified technology company" is made on a separate company basis. Therefore, a subsidiary formed by a large, multi-national company (e.g., a Fortune 500 company) to engage in a qualifying activity would allow that subsidiary company to apply to sell its NOLs or R&D credits.

This is a competitive program for which the State has allotted $40 million of tax benefits each year. In order to qualify for this year's largesse, companies who are interested in selling their losses or credits must submit an application so that it is received by the NJEDA by June 30, 2004. The applicant's tax return must also be filed by that date. Applications must be accompanied by a $1,000 "application fee," up from $500 in prior years. Applications received after June 30 would be eligible for next year's program.

No more than $10 million of tax benefits can be sold by one company over the life of the program.

Application forms can be downloaded from the NJEDA web site (www.njeda.com) or by calling any member of the tax department at Amper Politziner & Mattia, LLP

Phil Politziner CPA, President, Amper, & Alan Wink, Co-Director, Technology Group, spoke at the NJTC Bootcamp in June.

Phil Politziner moderated a panel and Brian Downey CPA, Co-Director, Technology Group, presented at the NJTC Capital Conference in January.

Lee Smith, Director, Internal Audit, wrote an article on Internal Controls for LifeSciTech magazine.

Tammy Hersh CPA, MBA, ABV, wrote an article on the Impact of Sarbanes-Oxley on Private Companies. It was published in TechNews in October. Tammy is a member of the firm's Litigation & Valuation Group and the Technology Group.

The new Fraud Standard was the topic of Jim Seary's article for the November issue of TechNews. Jim is a CPA and a member of the Technology Group.

Amper co-sponsored the First Annual Biomedical Engineering Showcase in February