TRENTON-As many New Jersey households scramble to complete their income tax returns on time, their options for lowering the amount they owe are limited compared to what some of the biggest companies doing business in New Jersey are allowed to do.

Reforms to the state's Corporate Business Tax Reform Act in 2002 plugged some loopholes, but companies continue to create and operate entities that shift income to other states just to avoid taxes. A new report from New Jersey Policy Perspective calls on the state to end this practice by joining the 20 other states that require a procedure known as combined reporting.

Big Firms Get Big Breaks: Time to Reform the Reforms, by NJPP Research Director Mary E. Forsberg, says combined reporting is a better approach than the state's current practice of sporadic and costly court challenges when companies are thought to be evading taxes. The 2002 reforms gave state officials authority to require combined reporting on a case-by-case basis when suspicious activity is suspected--but to date they have never used that power.

Combined reporting requires companies to put together profits from all related subsidiaries--both in-state and out--and only then determine what portion of those profits are taxable in that state. Multi-state companies must apportion their profits according to state formulas which consider how much of the company's property, payroll and sales are in each state.

The primary benefit from this is that it nullifies most tax avoidance schemes that rely on income shifts to reduce taxable income. States that do not require combined reporting have no alternative other than to continually attempt to monitor and interpret millions of dollars in inter-company transactions. This requires substantial state resources for auditors and lawyers. Experience shows it is difficult for these public servants to stay ahead of the highly compensated tax attorneys and accountants employed by companies to find and exploit new loopholes because they are constantly creating new ones.

The "Geoffrey" case was one of the best known of these strategies. Geoffrey the Giraffe is the trademark of Toys R Us. The toy company created a company in Delaware that owned that trademark, and Toys R Us stores in many states paid this Delaware company a fee for using the trademark. This effectively shifted profits out of higher tax states and into Delaware. This was an advantage for Toys R Us because Delaware does not levy corporate income taxes on earnings from such intangible assets as trademarks. So, profits transferred in this manner are free of state corporate income taxes. The 2002 law-changes prohibit shifting such royalty payments for the purpose of evading New Jersey taxes, but generally only on a case-by-case basis. Combined reporting would close these loopholes more effectively.

For the most part, New Jersey still treats each subsidiary or affiliate corporation in a related family as a separate entity, allowing them to file separate tax returns. The only exception is casinos, which are required to file combined reports. In 1999, approximately 21,000, or eight percent, of the corporations filing New Jersey returns had related places of business outside the state and would have been affected by mandatory combined reporting. Most were large, profitable firms with affiliated companies both in and out of the state. These companies incur approximately 60 percent of the state corporate business tax liabilities, according to the Division of Taxation.

Just as the Geoffrey loophole was closed, another opened. The case concerns $11.7 million in dividends paid in 1997 to UNB Investment Company by Bridgewater Mortgage, a real estate investment trust (REIT) whose stock was entirely owned by UNB. Bridgewater Mortgage deducted the $11.7 million dividend it paid to UNB Investment Company from its New Jersey taxable income. UNB, in turn, excluded those same dividends from its New Jersey taxable income under the provision allowing a corporate taxpayer to exclude dividends from a subsidiary. Because of these two actions, the $11.7 million entirely escaped taxation in New Jersey.

Under combined reporting, multi-state corporations would be unable to eliminate their state tax liabilities by shifting their income through fees and rents to subsidiaries.

"Combined reporting would bring predictability and consistency to the corporate tax process," said NJPP President Jon Shure. "It would provide the state with millions of dollars in much-needed revenue and also level the playing field for small, local businesses. Unlike multi-state firms, small businesses have nowhere to shift their profits."

In addition to calling for combined reporting, the NJPP study also recommends greater disclosure on the part of the state regarding which companies pay taxes, and how much.

In Fiscal Year 2006, New Jersey collected approximately $2.8 billion from the corporate business tax (compared to $1.3 billion in Fiscal Year 2001 before the reforms). Knowing who pays the tax, and how much they pay, allows for debate on who should pay the tax.

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