Commissioner of Internal Revenue v. Brokertec Holdings Inc, No. 19-2603 (3d Cir. 2020)
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The New Jersey Business Employment Incentive Program provides cash grants for companies willing to relocate or expand to New Jersey. A company receiving the grant must maintain a minimum number of employees and remain at the new location for a certain time period but there are no restrictions on how the company can use the grant, which is calculated as a percentage of state income taxes withheld from the wages of the company’s employees at the new location. In 2011, Garban’s offices in the World Trade Center were destroyed, and First Brokers’ nearby offices were rendered uninhabitable. Both companies, subsidiaries of BrokerTec, entered into agreements for 10-year Incentive Program grants. From about 2004-2013, the state paid BrokerTec about $170 million, which was used to purchase stock to expand into other trading markets.
In 2010-2013, the companies' consolidated tax returns excluded $56 million in grant payments as non-taxable, non-shareholder contributions to capital under 26 U.S.C. 118. The IRS issued a deficiency notice. The Tax Court held that the grants were capital contributions. The Third Circuit reversed. Because the state did not restrict how BrokerTec could use the cash and because the grants were calculated based on the amount of income tax revenue that the new jobs would generate—the grants were taxable income, not contributions to capital.
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