This article is the first in our series regarding how to achieve optimal results in resolving certain types of state tax and incentive disputes. Because of a new E-Verify push by the Nebraska Department of Revenue, we are dedicating Part 1 of this series towards this issue.

State Tax & Incentive Defense Protocol

In resolving any state tax and incentive dispute, we follow a certain protocol developed over many years, going back to principles learned from one of our founders—tax and litigation attorney Jack North. This is to help ensure that we have considered all potential defenses and taken other actions that help achieve successful resolution of the dispute.

The main components of this protocol are included on page 24 of this issue. Certain parts of this protocol are specifically illustrated below for the E-Verify R&D Credit audits and appeals we are seeing.

Application of Protocol to E-Verify R&D Credit Audits & Appeals

In 2009, the Nebraska Legislature passed a law requiring companies to electronically verify the work eligibility status of new employees to receive incentives for hiring those employees (such as under the 2005 Nebraska Advantage Act and other incentives).

In addition, the law included a requirement that companies must electronically verify the work eligibility status of new employees to claim the R&D Refundable Credit under the Nebraska Advantage Research and Development Act (R&D Act). Specifically, the statute stated: “The Tax Commissioner shall not approve or grant to any person any tax incentive under the Nebraska Advantage Research and Development Act unless the taxpayer provides evidence satisfactory to the Tax Commissioner that the taxpayer electronically verified the work eligibility status of all newly hired employees employed in Nebraska.”

The statute is broad, vague, and imprecise. The Department of Revenue has interpreted this to mean that the failure to, promptly after hire, verify even one new Nebraska employee in a year will cause a company to lose all its R&D credits under the R&D Act for that full year (which we call the “One Strike and You’re Out Rule”).

We’ve recently seen several disputes initiated by the Department of Revenue in which the department has claimed that the company did not meet the electronic verification requirements of this law. In interpreting this law, the department unilaterally imposed its own (various) interpretations of this law (also published in a Revenue Ruling) and has claimed that companies must complete verification through the federal E-Verify system within a very short time after a new employee is hired. The department has been imposing various deadlines by which to E-Verify (e.g., 3 days, 14 days, a year) and has tried to impose its interpretations on companies through the issuance of a number of assessments.

As we work with companies and their CPAs to file (or amend) protests to the department’s assessments, we have developed a number of defenses to the department’s interpretations. While space does not permit us to cite case law and other legal support for these, nor to cover all the potential defenses in this article, we still want to review several of the defenses—based on what this statute gives us and doesn’t give us. Because of the vagueness of the statute, these defenses (which have not yet been defended in court for the R&D Credit) include the following:

• The E-Verify Fully Occurred. Of course, start here. Press to demonstrate that E-Verify was promptly and fully achieved. If someone was missed, don’t concede that year or the case. Look to other defense positions.
• R&D Credit Disallowance Isn’t Authorized. What the statute says and doesn’t say is critical. The statute only says the tax commissioner “shall not approve or grant” the R&D Credit to any person. However, approval or granting is not needed. It is obtained by a company requesting it on its tax return. The statute does not give the tax commissioner the authority to disallow it.
• The Department Is Overstating the R&D Penalty. The penalty for any noncompliance with the electronic verification requirement under the Nebraska Advantage Research and Development Act is at most the loss of the amount of the credit attributable to such nonqualifying employee’s compensation, not a loss of all credits for that year.
• The Department of Revenue Cannot Create Its Own Timeframe for Verification. The Legislature did not include a timeframe for verification in the statute itself, so the Department of Revenue cannot impose its own timeframe. A company can verify its new employees at any time based on the statute itself.
• The Department’s Current Interpretation Contradicts the Tax Commissioner’s Testimony to the Legislature About the Law. In testimony to the Legislature, a prior Nebraska tax commissioner specified that the Department of Revenue allows companies to count employees as verified under the E-Verify system once that verification occurs, without a time limit. The department’s assessments directly contradict that public assurance.
• E-Verify Sign Up Is All That Is Needed. We believe, given the Legislature’s intent, a company may comply with the electronic verification requirements by simply signing up to electronically verify its newly hired employees under the federal E-Verify system. This is based on the department’s inconsistent interpretation of two statutory provisions that have the same language.
• E-Verify Isn’t Required. The statute doesn’t specify E-Verify. It only says “electronically verified,” so clearly another method to verify work status should be sufficient.
• The Legislature Was Concerned About Ineligible Employees, Not E-Verification. The Department of Revenue is misapplying the R&D Act by its focus on e-verification timeframes instead of a focus on, and confirmation of, whether an employee is eligible to work in Nebraska.
• The Law Itself Is an Unconstitutional Delegation of Authority to the Department. The law itself specifies that a taxpayer must provide “evidence satisfactory to the Tax Commissioner” to establish that the taxpayer met the law’s requirements but provides no objective standards or direction to the department as to what evidence will suffice. That is an unconstitutional delegation of authority by the Legislature.
• Void for Vagueness. The statutes defining the electronic verification requirements do not provide adequate notice of what is required and do not supply adequate standards to prevent arbitrary enforcement. They are void as unconstitutionally vague.

These defenses to the E-Verify incentive disallowances have not yet been presented before a Nebraska court. So, we can’t be sure how a court will view them. Nonetheless, we do believe that each has a reasonable and solid legal basis and should be pressed with the Department of Revenue—during the audit phase as well as on the Appeal of a Notice of Deficiency. (Note: A legislative bill has been introduced to fix the statute, but as of the date of publication, its passage is uncertain.)

If companies filed a protest before we became involved, and did not include one or more of these defenses when filing their initial protest, we’ve been working with them to file a supplement to the protest that includes these additional defenses.