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Nebraska Residency For Tax Purposes: The Tax Trap Of Accidental Residency And A Tax Opportunity For Nebraska Resident Trusts

Whether an individual or an entity is a resident of Nebraska for tax purposes can have a dramatic impact on the amount of Nebraska taxes which that individual or entity owes. For that reason, you can bet that the Nebraska Department of Revenue is focused on whether an individual or entity is legally a resident of Nebraska for tax purposes.

We wanted to alert you to two significant issues regarding Nebraska residency. The first involves a potential tax trap: whether a person has unknowingly taken actions that make that person a Nebraska resident. The second involves a potential tax opportunity: whether a trust may be able to avoid Nebraska taxation because Nebraska’s tax laws violate the U.S. Constitution.

Tax Trap: Have You Unknowingly Made Yourself A Nebraska Resident For Tax Purposes?

In our practice, we’ve seen a renewed focus by the Nebraska Department of Revenue regarding the classification of an individual as a Nebraska resident for income tax purposes. This is particularly true for persons who a) were once Nebraska residents; b) keep a house or apartment in Nebraska; and c) intend to be a resident of another state for tax purposes.

Under Nebraska tax law, there are two distinct ways to be a Nebraska resident for tax purposes. First, an individual is a Nebraska resident if that person maintains a permanent place of abode in Nebraska (meaning a house, apartment, condominium, etc.) and spends in the aggregate more than six months of the taxable year in this state. Therefore, if an individual has a home in Nebraska throughout the year and that individual wants to be a nonresident of Nebraska for tax purposes, that individual must not be physically present in Nebraska more than six months of the year (in total). If that individual is physically present in Nebraska more than six months of the year (in total), that individual will be a Nebraska resident for tax purposes.

We realize that there are many retirees who want to avoid Nebraska’s winters but wish to keep their home in Nebraska for family or other reasons. If those retirees do not wish to be Nebraska residents for tax purposes, they should be prepared to document their presence outside of Nebraska for more than six months of the year. Documentation which may establish physical location may include travel records, credit card or purchase receipts (showing purchases in other states) and event tickets.

The second way to be a Nebraska resident is to be legally domiciled in Nebraska. Domicile is a legal determination involving many factors, but can be summarized as the place where an individual has his or her true, fixed, and permanent home and principal establishment; and, to which whenever he or she is absent he or she has the intention of returning. Actual residence is not necessarily domicile.

If a Nebraska resident no longer wants to be a resident of Nebraska for tax purposes, and therefore wants to change his or her legal domicile, the Department of Revenue has announced that intent to change a person’s domicile can be shown by:

  • Purchasing a home in another state for use as a principal residence;
  • Paying taxes as a resident of another state;
  • Obtaining a driver’s license as a resident of another state;
  • Registering a motor vehicle as a resident of another state; or
  • Registering to vote in another state.

When determining domicile, the Department has also announced that it will consider the following factors (although this list is not exhaustive, so the Department may also consider other factors as well):

  • The size, value, and nature of a person’s Nebraska residence compared to that person’s residence in another state;
  • A person’s employment or business connections in both locations;
  • The physical location of items that have significant sentimental value to the individual; and
  • A person’s social, community, and family ties in both locations.

If a person qualifies as a Nebraska resident under either test, that person will likely be required to pay Nebraska income tax as a resident. Therefore, it is important for persons trying to avoid Nebraska residency for tax purposes to be aware of both these tests and to take the actions necessary to qualify under both tests as a nonresident.

Tax Opportunity – Can A Trust Created By A Nebraska Resident Avoid Nebraska Taxation?  Maybe It Can, Under The U.S. Constitution.

Under Nebraska’s tax rules for trusts that are taxable entities (where the income is not taxed to the creator of the trust or some other party), trusts are Nebraska residents if they a) consist of property transferred by the last will and testament of a decedent, who, at his or her death, was domiciled in Nebraska; or b) were created by, or which consist of property of, a person domiciled in this state at the time the trust became irrevocable. (The test for Nebraska domicile is discussed above.)

In addition, Nebraska tax law states that, if the creator of a trust is domiciled in Nebraska when the trust becomes irrevocable, the trust will be considered a Nebraska resident trust for tax purposes for the entire life of the trust. This is true even though the actual property held in the trust and/or the trustee are located in another state. Therefore, once a trust becomes a Nebraska trust for tax purposes, it is often a Nebraska resident trust forever. No actions taken by the creator, trustee or beneficiaries can change that tax result.

Nebraska is not the only state with such a law. In fact, 10 jurisdictions require no factor beyond the residency of the creator to tax all of the trust’s income. Pennsylvania was one such state.

In a 2013 Pennsylvania case, a group of taxpayers challenged this rule under the U.S. Constitution. In the Pennsylvania case, a pair of trusts were created in 1959 by a resident of Pennsylvania. The trusts were administered entirely outside of Pennsylvania, none of the assets in the trusts were located in Pennsylvania, and the trusts had no income from Pennsylvania sources. However, the beneficiaries of the trusts were all Pennsylvania residents.

Notwithstanding the residency of the beneficiaries, a Pennsylvania court ruled that Pennsylvania’s taxation of those trusts violated the Commerce Clause of the U.S. Constitution. This was because the Pennsylvania court determined that the trusts lacked the necessary physical presence in Pennsylvania to establish substantial presence in Pennsylvania. This substantial presence was required for Pennsylvania to have the legal right to tax those trusts.

The Pennsylvania state taxing authorities decided not to appeal this decision.

While we don’t know whether a Nebraska court would follow this Pennsylvania decision, it could provide a legal basis for a trust to a) challenge a determination by the Nebraska Department of Revenue that the trust was a Nebraska resident for tax purposes; or b) file an income tax refund claim with the Nebraska Department of Revenue if the trust has paid Nebraska income tax as a resident trust. So, in that respect, the decision could create a tax opportunity for you or your clients.