When it comes to preparing a tax return, creativity is usually a bad thing. It is not allowed (with good reason).
One notable exception comes in the area of state tax apportionment. Nebraska’s statutes certainly have rules which govern the apportionment of income between states. However, those same statutes allow companies to utilize a special, nonstatutory method if the Department finds that: a) the statutory apportionment rules do not fairly represent the taxable income that is reasonably attributable to the business operations conducted within Nebraska by a taxpayer; b) the taxpayer’s factual situation is unique and nonrecurring; and, c) the statutory apportionment method otherwise produces incongruous results.
This provision was a realization by the Legislature (and by the drafters of the Uniform Division of Income for Tax Purposes Act, which wrote this provision for use around the country) that the normal rules may not always be good representations of how income should be divided for tax purposes. The provision was intended to give the Department of Revenue broad authority to vary the apportionment method where the normal rules do not fairly represent the extent of the taxpayer’s business activity in Nebraska. The goal is to fairly apportion income among the states which have contact with the income.
In practice, our experience has been that many companies use special apportionment methods when preparing their Nebraska income tax returns. This is generally because the normal method does not fairly represent the extent of that company’s business activity in Nebraska. In that circumstance, there is another method which is a better representation of the company’s multi-state activity and which may have better tax consequences. Less commonly, companies use special apportionment methods because they do not understand how the statutory method should apply to their company.
Sometimes a company formally petitions the Department of Revenue for approval to use a special apportionment method before the company adopts that method within its return. This has always been the preferred approach. It allows all parties to get comfortable with the special method and generally results in a better chance that the Department will accept a special appointment method. We have also seen many times that a company will simply use the special apportionment method on its return. The Nebraska Department of Revenue may have accepted these returns without change for years. If an issue from using the special apportionment method arose during an audit, the company could still receive formal approval to use this method during the audit and protest process.
Unfortunately, this practice of adopting a special apportionment method on the return, without prior formal approval by the Department of Revenue, is likely over. On December 27, 2015, revised corporate tax apportionment regulations issued by the Department of Revenue became effective. These regulations state, among other things, that a taxpayer must file a formal petition with the Tax Commissioner to request a special apportionment method before filing any returns that propose to use the special apportionment method.
The filing of a petition with the Tax Commissioner can be the start to a formal contested case before the Department. As such, there are a number of legal requirements that each petition must meet. Failure to meet these requirements can cause a petition to be dismissed procedurally, without consideration for the merits of the petition. For example, the petition must demonstrate that the statutory method does not fairly represent a company’s taxable income attributable to Nebraska and propose a special method that does fairly represent the company’s taxable income attributable to Nebraska. We also strongly recommend that a petition include a request for a hearing before the Department, because the failure to request a hearing causes a company to lose a number of its procedural protections before the Department.
If your or your client’s company has been using a special apportionment method without formal approval by the Department of Revenue, or would like to use such a method in the future, we would be happy to discuss the procedure for filing a petition with the Department of Revenue. Please contact a member of the McGrath North Tax Group to discuss this further.