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Nebraska Won't Treat Repatriated Income as Dividend

Posted on Sep. 18, 2019

Nebraska's new guidance on the taxation of repatriation income will peg the state as a “significant outlier” vulnerable to litigation, experts say.

The Nebraska Department of Revenue on September 13 issued General Information Letter 24-19-1 on the IRC section 965 transition tax for tax year 2017. The guidance clarifies the apportionment of repatriated income and the classification of net IRC section 965 inclusion income.

States have varied in treating section 965 income, or accumulated post-1986 deferred foreign income, with many having excluded it from their base. Nebraska’s new guidance advises taxpayers to include the net repatriation income.

“Nebraska is a significant outlier in the way it’s treating 965 income,” Katie Quinn of McDermott Will & Emery told Tax Notes September 17. “The vast majority of states are excluding such income from taxes, either through the dividends received deduction or through a separate subtraction of income.”

The information letter also deems repatriated income as earned, rather than a dividend, stating that “examination of the IRC, Treasury Regulations, and related Tax Court cases establish that the net IRC section 965 inclusion income . . . is not a foreign dividend,” adding that the income is added to subpart F income and doesn’t meet the definition of a dividend. No dividend deduction will be allowed, according to the guidance.

The guidance states that since repatriation income is a unique, nonrecurring situation, the tax commissioner has the authority to allow special apportionment rules. Because excluding repatriated income from the sales factor or including gross income in the numerator would “produce incongruous results relative to other taxpayers,” the department advised taxpayers to include the section 965(a) income in the denominator, but remove it from the numerator.

“This is income earned for up to 30 years and recognized in federal taxable income in a single tax year,” DOR spokeswoman Lydia Brasch said in a September 17 email to Tax Notes. “The share that was apportionable in each of those years would have varied in each of those years. In fact, Nebraska moved from three-factor apportionment to single-sales-factor apportionment during that time. The domicile of the corporation may have changed during those years. Taxing income earned over all those years based on this year’s factors only produces inconsistent results between all taxpayers with respect to how income is earned and in what year. The only way to treat taxpayers consistently is to leave the income out of the numerator altogether.”

Brasch added that other reasons for excluding gross repatriation income from the numerator of the apportionment factor were that the income was earned overseas and that adding it to the numerator would distort the factor and include a greater portion of domestic income than was apportioned to Nebraska.

Quinn disagreed with the state's treatment of repatriation income as deemed earned, pointing out that Nebraska’s deemed dividend deduction also applies. She also argued that there would be additional litigation over the fact that the receipts of controlled foreign corporations were not included in the denominator of the apportionment formula and that the ratio should be diluted even further.

“I think there will for sure be litigation, unless the department backs off this position,” Quinn said. “Taxpayers should — and I think they will — fight back. There’s a lot of money at stake here.”

Because so much money is at stake, Darien Shanske, professor at the University of California, Davis, School of Law, said that is all the more reason for states to tax one-time repatriated earnings, adding that the “state would likely win.”

“Kudos for Nebraska for including the income when so many states have not,” Shanske told Tax Notes September 17. “A certain amount of that money is Nebraska’s money, and the state is right to bring it back into its base. . . . [R]epatriation is not a dividend and should not be treated as a dividend, as that money that has been sitting out there has at least in part been shifted out of the domestic tax base in the hope that there would eventually be another repatriation holiday.”

While Shanske said his initial impression of Nebraska's guidance is that it's a reasonable way to go, he felt he had outlined a better approach in his April 2018 Tax Notes article with David Gamage, professor of law at Indiana University's Maurer School of Law. That article suggested that a tax on repatriated income should be accompanied by findings that a significant amount of the income had been earned inside the country and should be taxed at a higher rate.

Shanske said Nebraska’s plan is better than what many states are doing and that many states could take significantly more aggressive positions on this unique, one-time event.

“It’s still not too late for states to do this; and if there is a recession next year, states may revisit this mistake [of not taxing repatriated income],” Shanske said.

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