Section 965 doesn’t qualify for Nebraska’s Dividend Received Deduction

Nebraska’s Dividend Received Deduction (DRD) Rule

For corporate income tax purposes, Nebraska provides a deduction for “dividends received or deemed to be received from corporations which are not subject to the Internal Revenue Code.” See Neb. Rev. Stat. Sec. 77-2716(5), herein after referred to as the DRD Rule.

Background

In 2017, Precision Castparts Corp (Precision) included income pursuant to IRC section 965 (Sec. 965) in its federal income tax return. Precision did not include the Sec. 965 income in the taxable base in the original 2017 Nebraska corporation tax return, but in 2021 Precision amended the return to include it.

In 2022, Precision filed a request with the Nebraska Department of Revenue seeking the authority to amend its 2017 Nebraska return to deduct Sec. 965 income from its taxable base pursuant to the DRD Rule. Precision argued the Sec. 965 income should have been deducted from income on its Nebraska return as “dividends...deemed to be received.”

The tax commissioner concluded that Sec. 965 was a “deemed inclusion” rather than a “deemed dividend” and as such, is not deductible under the DRD Rule. In response, Precision turned to the district court to review the tax commissioner’s order. The district court affirmed the order. It reasoned that for Sec. 965 income to be deductible under the DRD Rule, “a legislative body with the power to do so must... ‘deem’ the 965 inclusion income a dividend for it to be treated as a deemed dividend...”. Additionally, the court further reasoned that there was no distribution and as such, no dividend.

Nebraska Supreme Court decision

In response, Precision appealed the decision, and the Nebraska Supreme Court (the Court) accepted the case. The Court stated, “there does not appear to be any contention in this case that Section 965 inclusion should be considered a “dividend,” per se, because no actual distribution was made by Precision Castparts’ CFCs [Controlled Foreign Corporation] or received by Precision Castparts. The issue instead is whether Section 965 income qualifies as “dividends...deemed to be received...” under the language of Sec. 77-2716(5).”

In its analysis, the Court stated, “we see nothing in the language of Section 965 that explicitly states the inclusion is to be considered or treated as dividends.” As such, Sec. 965 itself did not deem the income inclusion as dividends.

Further, in its analysis, the Court cited to the recent U.S. Supreme Court decision in Moore v. United States, 144 S. Ct. 1680 (2024), which analyzed the constitutionality of Sec. 965. In citing the Moore decision, the Court stated “the Court indicated that Section 965 does not operate by deeming a distribution to have been made to shareholders. Instead, Section 965 treats the inclusion as pass-through income and attributes the retained earnings of a CFC to its shareholders.” As such, Sec. 965 does not deem shareholders to have received a distribution from the CFCs but rather, Sec. 965 requires a passthrough treatment which attributes earnings realized by the CFCs to shareholders without regard to whether the earnings are distributed.

As such, based on the Moore decision and the language of Sec. 965, the Court concluded that Sec. 965 income does not qualify as “dividends...deemed to be received” under the DRD rule and affirmed the order of the district court.

See: Precision Castparts Corp. V. Nebraska Dept. Of Rev., 317 Neb. 481 (Aug. 30, 2024).

What’s Next?

The decision above is generally in line with and confirms guidance previously issued by Nebraska related to the deductibility of Sec. 965 under the DRD rule. Despite Nebraska’s narrow interpretation of “deemed dividends,” it has issued guidance regarding the inclusion of such nondeductible income in the denominator of the apportionment factor, which may offer relief for taxpayers.

Further, the decision may have an impact on other states’ interpretation of the deductibility of other types of foreign income (e.g. Subpart F) under their laws.

If your business has any questions, please reach out to your Baker Tilly state tax advisor.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.