An Update From Lincoln: Department Of Revenue Contentions Impacting Many Nebraska Companies And Business Owners
In our state and local tax practice, we are currently seeing some issues that are impacting a number of Nebraska companies and business owners that we wanted to comment on.
Issue 1: Continued Scrutiny of Nebraska’s Special Capital Gains Exclusion
In 1987, the Nebraska Legislature enacted a tax exclusion for Nebraska residents who sell stock that they acquired while employed by a Nebraska based company on account of their employment. This exclusion is commonly referred to as the Special Capital Gains Exclusion. Certain qualifications need to be met in order to claim the Exclusion, including that the underlying corporation has 5 or more shareholders at the time of the shareholder’s first sale for which the Exclusion is claimed.
Over the past few years, the Nebraska Department of Revenue has been challenging the eligibility of shareholders for the Exclusion using multiple theories. Initially, the Department had focused its challenges on corporations that acquired additional shareholders, to reach five or more, just prior to the sale for which the Exclusion would apply. The Department contended that some of those transactions were without economic substance. In the recent case Stewart v. Department of Revenue, which we reviewed in November, the Nebraska Supreme Court ruled that the Department was not allowed to question the economic substance of an ownership interest in a corporation for this purpose. Still, we believe care must continue to be taken in establishing the corporation’s “ownership.”
More recently, the Department has been questioning whether stock that is placed into a partnership or LLC, and then is transferred to a trust (as may be done for several estate planning reasons), is still eligible for the Exclusion. While there is a Nebraska District Court case that suggests the Exclusion is still available after stock is placed into an LLC or partnership, the Department is still considering how this case applies to these situations in light of the Stewart case.
Issue 2: The Recharacterization of Information Technology as Security
There can often be a question as to the sales tax effect when one provider sells multiple products or services. An example was the recent case Enterprise Rent-A-Car v. Nebraska Department of Revenue. The issue in Enterprise was whether separately stated charges for insurance and refueling, incurred as part of renting a car, should be taxed for sales tax purposes like the car rental fee. In Enterprise, the court recognized that neither charge would exist without the lease transaction and that those charges were a “necessary part of the total consideration paid to lease the vehicle.” So, even if charges for insurance or fuel may not be taxable on their own, they were taxable when paid as part of a taxable car rental transaction.
Recently, we’ve seen the Department contend that numerous data center or information technology services, which are not by themselves taxable for sales tax purposes, are actually taxable because the data center or technology company provides some sort of security as part of its services.
Many security services, when separately performed, are taxable in Nebraska. This does not mean, however, that any provision of security makes a transaction taxable. If that was true, every rental of an apartment or office which features a security guard, secured access or even key access would be taxable.
While the facts of each specific transaction differ, we believe that, for many transactions, the Department’s new contention is not a correct application of Nebraska’s sales tax rules. The Department may, for many companies, be misinterpreting Enterprise by contending that the provision of security by a data center or information technology services provider as an incident to their core service is somehow the provision of multiple services. The Department may also be misclassifying the core transaction as a taxable security service, instead of a nontaxable data center or information technology service.
Issue 3: Inserting Words That Were Not Enacted.
We continue to see the Department wanting to administratively insert words into the language of a number of statutes that were not inserted by the legislature. The courts have, in multiple cases, instructed the Department not to do this. Often just a careful reading will help to defend several of the tax positions being taken.
If your company or client is dealing with either of these issues with the Department, please contact a member of the McGrath North Tax Group if you would like to discuss the best way to respond to the Department.