New Jersey Pass-Through Affirmed By State Tax Court

Washington, DC, February 25, 1997 - Since 1983, the Institute has been seeking recognition by all fifty states of the exemption from state tax for mutual fund dividends derived from interest on federal obligations. Although all states now permit a fund to pass-through to its shareholders a dividend that will be free from state tax when derived from federal interest, a few states impose asset thresholds on this pass-through. For example, New Jersey requires that 80 percent of a fund's assets be invested in federal obligations for the fund to pay a dividend exempt from New Jersey state tax.

In 1993, the Institute filed a suit in the New Jersey Tax Court seeking a declaratory judgment striking down the New Jersey threshold requirement. The New Jersey Tax Court ruled that the state threshold requirement cannot be applied to a mutual fund. The Court held that the taxation of shareholders of funds not meeting the 80 percent asset threshold would be inconsistent with the Supremacy Clause of the U.S. Constitution.