This article is the second in our series regarding how to achieve optimal results in resolving certain types of state tax and incentive disputes. We are dedicating Part 2 of this series towards sales and use tax audits and appeals.

State Tax & Incentive Defense Protocol

In Part 1 of this series, we discussed that, in resolving any state tax and incentive dispute, we follow a certain tax resolution protocol we’ve developed over many years. This helps to ensure that we have considered all potential defenses and taken other actions that help achieve optimal resolution of the dispute.

The main components of this protocol were referenced in Issue 2, 2023 of the Nebraska CPA magazine. We apply this protocol in resolving sales and use tax audits, protests, and appeals and many of the common issues in those audits, protests, and appeals that we see.

Key Issues in Sales & Use Tax Audits & Appeals

While each company’s situation is different and has something unique about its business and business model, our experience in handling sales and use tax audits and appeals over many years has highlighted certain issues that arise in many audits, protests, and appeals.

We are focusing on several of the key issues we have seen arise in multiple situations, so you can help your clients address these issues and prepare for the potential that the Nebraska Department of Revenue will audit, or assess tax, based on these types of issues.

The first step in resolving an issue is to plan ahead to avoid it.

While these certainly do not represent all the issues we are seeing, these are among the most common—and apply to multiple industries. We are not addressing here the sales tax issues that arise under Nebraska’s tax incentive projects.

Issue: Taxable Nexus

The most fundamental question for any company is whether that company has sufficient presence in a state to be subject to that state’s laws.

Issue: Sales Tax on Software Development

The Department of Revenue often questions whether sales tax is due on custom software developed by outside consultants, normally in staff augmentation projects.

Issue: Software Used in Multiple States

The Department of Revenue has often taken the position that, if software meant to be used by company personnel across the country is first delivered to Nebraska, the amount spent on such software is wholly subject to Nebraska tax.

Issue: Where a Transaction Is Sourced

The place at which a transaction is sourced comes up especially in direct mail, telecommunications, and export sales.

Issue: Tax on Cloud Computing/Data Center Services

The taxation of cloud computing and data center services is often being challenged—in Nebraska as well as in other states.

Issue: Tax on Digital Goods & Services

The tax law is developing, along with the technology and new business models, on how a transaction involving digital goods or services is classified for tax purposes.

Issue: Bundled Transaction Rules

An improperly structured purchase transaction, in which a purchaser receives multiple goods or services for one, non-itemized price, can cause tax to be imposed on the purchase of otherwise nontaxable goods or services.

Issue: Classification as Taxable Goods or Nontaxable Services

Whether a purchase transaction is taxable tangible personal property or nontaxable services, is based on a multiple-factor test.

Issue: Manufacturing Sales Tax Exemption

Purchase of manufacturing equipment is exempt from sales/use tax if purchased direct by a manufacturer. It needs to be clear whether equipment is purchased directly by a company (versus a contractor) and whether the company qualifies as a manufacturer.

Issue: Business Buyer’s Liability for the Seller’s Unpaid Taxes

In certain cases, Nebraska tax law can require the purchaser of a business to pay the unpaid taxes of the predecessor owner.

Issue: Use-Based Exemptions

These types of exemptions depend on the scope and nature of the specified use of the product by the purchasers.

Issue: Transfers Between Owners & Their Entities or Between Related Entities

While many transfers between owners, and related entities, can be tax free, a number of conditions must be met under Nebraska tax law for that to be the result.

Issue: Product-Based Exemptions

These types of exemptions depend on the true nature of the product.

Issue: Agricultural Exemptions

Nebraska has several exemptions available for agricultural producers, but these have various requirements that must be met to qualify.

Issue: Energy Use Exemption

Nebraska’s exemption for energy usage is significant but contains multiple conditions that can be the subject of questions with the Department of Revenue.

Issue: Entity-Based Exemption

The issue here is whether the entity meets the requirements for being sales-tax exempt.

Issue: Lease or Purchase

Whether a transaction, despite its form, is fundamentally a lease or purchase impacts the sales taxation.

Issue: Pollution Control Refund

Nebraska law establishes a tax refund available for equipment used in pollution control. Qualification is a multi-step process that includes review by the Nebraska Department of Environment and Energy.

Issue: Property Used by Business or Component Part of Another Product

For businesses, it is often a question of whether an item is consumed by that business (and therefore taxable) or whether it becomes a component part of the products that the business itself makes.

Issue: Contractor Sales Tax Compliance

Sales tax compliance is a significant issue for contractors and those selling building materials.

Issue: Common & Contract Carriers

Property used by common and contract carriers may be exempt from tax, but classification as a carrier comes with a variety of specific conditions.

Issue: Taxation of Aircraft

The ownership or lease of a private aircraft in Nebraska comes with several issues, including whether the initial purchase is eligible for a tax exemption in Nebraska.

Issue: Data Processing & Data Centers

The Department has been working to treat a portion of otherwise nontaxable data processing and data center fees as taxable security service fees.

Issue: Tangible Property Versus Real Property

The taxation of the purchase of personal property varies significantly from the purchase of real property. Classification of property as being real or personal is based on a multi-factor test.

Issue: Sampling & Projection

The Department’s sampling and projection methods often have a significant impact on the results under a sales and use tax audit. A good deal of challenges can be brought against an inappropriate method.

Issue: New Technology & New Business Models

As new technologies and new business models are being developed, the Department has been continuously looking at ways to impose taxation.

Issue: Proper Protest

The Department of Revenue has firm regulations on the requirements needed to file a proper, legal protest to a Department assessment. We are brought in at all stages of a dispute to help that dispute be resolved as favorably as possible. Still, when we’re brought in after an assessment is issued, we work with our clients to ensure that their protest meets all the Department’s regulatory requirements to challenge an assessment and that the protest properly requests a full administrative hearing. We’ve also addressed, in Issue 1, 2023 of the Nebraska CPA magazine, when legal counsel is required to be involved in a protest or appeal to a Department assessment.

Using the Tax Incentive Protocol

Optimal results can be achieved for each of these issues by following the “State and Local Tax and Incentives Resolution Protocol” available at www.NebraskaStateTax.com.