February 22, 2021
Nebraska Department of Revenue limits application of its dividends received deduction on Subpart F income
In Revenue Ruling 24-21-1 (issued February 17, 2021), the Nebraska Department of Revenue (Department) stated that Subpart F income is generally not a dividend or deemed dividend for purposes of the Nebraska dividends received deduction (DRD). The revenue ruling is advisory in nature but is binding on the Department.
Background on Nebraska Rev. Stat. Section 77-2716(5)
Nebraska Rev. Stat. Section 77-2716(5) provides a subtraction adjustment for "dividends received or deemed to be received from corporations [that] are not subject to the Internal Revenue Code" (IRC). This provision was enacted when Nebraska's corporate income tax scheme was restructured in 19841 in response to the Nebraska Supreme Court's decision in Kellogg Co. v. Herrington, 216 Neb. 138, 343 N.W.2d 326 (1984). The Kellogg case involved the inclusion in corporate income of dividends received from foreign subsidiaries. The court held that Nebraska taxable income, under the statutory scheme then existing, included dividends and interest paid to a taxpayer corporation by its foreign subsidiaries, but did not include the foreign subsidiaries' income. In addition to enacting Neb. Rev. Stat. Section 77-2716(5), the Nebraska legislature also enacted Neb. Rev. Stat. Section 2734.05(3), which only includes the part of a unitary business that is subject to the IRC in the Nebraska apportionment factor. These legislative changes evidenced an intent to limit Nebraska's corporate income tax to reflect a domestic approach.2
Department's recent guidance on applying Neb. Rev. Stat. Section 77-2716(5) to IRC Section 965(a) inclusion income
Since its enactment, Neb. Rev. Stat. Section 77-2716(5) has generally been applied by the Department to treat Subpart F income as a deemed dividend eligible for the state's DRD. The Tax Cuts and Jobs Act (TCJA) amended IRC Section 965 to require taxpayers to include in income an amount (i.e., the IRC Section 965(a) inclusion amount) based on the accumulated post-1986 deferred foreign income of certain foreign corporations that they own either directly or indirectly through other entities. The Department subsequently issued General Information Letter (GIL) 24-18-1 in December 2018 (revised by GIL 24-19-1 in September 2019) to reassess this newly created category of income subject to the Subpart F income rules. In these GILs, the Department took the position that income from an IRC Section 965(a) inclusion is not a dividend or deemed dividend deductible under Neb. Rev. Stat. Section 77-2716(5). The Department also provided instructions for reporting the IRC Section 965(a) inclusion amount along with apportionment factor treatment.
The Council on State Taxation is seeking a declaratory judgment in the Nebraska courts that the Department's position in GIL 24-19-1 is contrary to Nebraska law and should not be enforced. In addition, the Nebraska legislature is considering a bill that would allow taxpayers to deduct, under Neb. Rev. Stat. Section 77-2716(5), the IRC Section 965(a) inclusion amount for Nebraska tax returns filed before, on or after the bill's effective date, if enacted. This treatment would also apply to global low-taxed intangible income under IRC Section 951A, as reduced by the deduction available under IRC Section 250, for Nebraska tax returns filed before, on or after the bill's effective date, if enacted.
Nebraska Revenue Ruling 24-21-1: Department's position on Subpart F income
In informal communications with EY, the Department said it has been studying various categories of Subpart F income in the course of hearing appeals from taxpayers contesting assessments based on the Department's position in GIL 24-19-1. As a result of these studies, the Department has issued Revenue Ruling 24-21-1.
In Revenue Ruling 24-21-1, the Department states that Nebraska law (1) uses the same definitions for terms as federal income tax law, unless a different meaning is clearly required; and (2) does not define a "dividend or deemed dividend" for Nebraska income tax purposes. The Department cites IRC Section 316 and the opinion in Rodriguez v. C.I.R., 722 F.3d 306 (5th Cir. 2013) (Rodriguez) as authority to conclude that Subpart F income inclusions are not actual dividends because they do not involve any distribution or change in ownership. Citing Rodriguez, the Department further stated that Congress is explicit when treating certain inclusions as dividends (i.e., a deemed dividend). The Department found the "statutory silence," combined with specific instances in which Congress has treated other items as deemed dividends, supports its determination that Congress did not intend to generally afford Subpart F income deemed-dividend treatment. Accordingly, the Department concluded that Subpart F income is generally not a dividend or deemed dividend for purposes of Neb. Rev. Stat. Section 77-2716(5).
The Department identifies some specific instances in which certain Subpart F income inclusions have been expressly treated as deemed dividends and, thus, eligible for Nebraska's dividend received deduction under Neb. Rev. Stat. Section 77-2716(5):
Taxpayers must specifically identify Nebraska deductions for Foreign Personal Holding Company dividends on the Nebraska Schedule II, Form 1120N and attach Worksheet A, Schedule I, IRS Form 5471 as well as documents or worksheets that specifically identify the amount of Foreign Personal Holding Company dividends claimed. Any deduction for Subpart F income claimed as a dividend or deemed dividend other than those specifically designated in Revenue Ruling 24-21-1 will be disallowed.
Apportionment factor guidance
Revenue Ruling 24-21-1 provides guidance for apportionment-factor treatment of Subpart F income included in Nebraska apportionable income. Neb. Rev. Stat. Section 77-2734.14(3)(k), which provides a sourcing rule for sales other than sales of tangible personal property not specifically addressed elsewhere in the sourcing provisions, applies to Subpart F income. This rule requires receipts to be sourced in a manner that fairly represents the extent of the taxpayer's business activity in Nebraska. If this cannot be done for activity resulting in Subpart F income, then taxpayer must include Subpart F income in the sales-factor denominator and exclude the income from the sales-factor numerator.
The Department's guidance represents a significant departure from its long-standing treatment of Subpart F income. The guidance may also be inconsistent with the 1984 legislative restructuring of Nebraska's corporate income tax to reflect a domestic-only approach to taxation.
It is unclear at this time whether the Department will apply this new position prospectively or if it will apply it to returns filed in prior years. Revenue Ruling 24-21-1 does not contain any statements suggesting taxpayers should amend returns. In its most recent guidance on its treatment of IRC Section 965(a) inclusion income (GIL 24-91-1, Tax Alert 2019-1639), the Department expressly indicated that taxpayers should file an amended return if their originally filed returns improperly reported IRC Section 965(a) income inconsistent with GIL 24-91-1. More guidance may be needed on this question.
Taxpayers subject to Nebraska income taxes should continue to monitor developments in this area, including COST's challenge to the Department's position on IRC Section 965(a) income and the bill before the Nebraska legislature on the treatment of foreign-sourced income. On its face, the bill only addresses the Nebraska tax treatment of income recognized under IRC Section 965(a) and GILTI. Further amendments to that legislation may be needed to address the Department's latest position on the state's treatment of Subpart F income and other items reliant upon the federal Subpart F income rules.
1 Neb. LB 1124, 88th Leg. 2nd Sess. (1984) (LB 1124).
2 For a more robust discussion of the Kellogg case and subsequent legislative history see Larry D. Hause, Unitary Taxation: An Analysis of State Taxation of Multijurisdictional Corporations in Nebraska, 64 Neb. L. Rev. (1985).