By Nick Niemann and Matt Ottemann, McGrath North
As with all tax matters, state and local taxes offer the opportunity to choose to plan ahead, or to choose to not plan ahead. Planning ahead usually results in the better outcome. In either situation, all taxpayers are subject to being audited. All audits are either resolved at the audit level or resolved on appeal.
When a state tax matter is not resolved upon audit, a Notice of Deficiency will normally be issued. It must be responded to with a full understanding of the facts and legal issues. The failure to properly respond can mean that the client is stuck owing the alleged tax — regardless of the merits of their case. So, we’ve highlighted some key issues — and pitfalls — for tax practitioners to be aware of when their clients receive a Nebraska Notice of Deficiency.
A Legally Valid Protest Must Be Filed
The first step in responding to a Notice of Deficiency occurs when the Petition for Redetermination (often just called the “Protest”) is filed. Nebraska law establishes that, once issued, a Notice of Deficiency must be protested in a set timeframe. This is generally 60 days but can vary based on the type of notice that has been issued. Failure to file the Protest in the statutory timeframe often means the client loses the opportunity to contest the notice.
The Department of Revenue has, by regulation, established certain legal requirements to constitute a valid Protest to a Notice of Deficiency. The failure to meet these requirements could mean that the Protest would be void, so the full tax would be due.
The failure to properly respond can mean that the client is stuck owing the alleged tax — regardless of the merits of their case. So, we've highlighted some key issues — and pitfalls — for tax practitioners to be aware of when their clients receive a Nebraska Notice of Deficiency.
What Happens After a Protest Is Filed
In the usual sales/use or income tax appeal, the case is assigned to a Department of Revenue attorney. Both parties need to further develop the facts and the legal grounds, and work towards possible settlement.
If the case cannot be resolved in this “informal” process, then either party may request that the case be set up for a formal hearing with a hearing officer appointed by the tax commissioner. The purpose of this hearing is two-fold. The first is to create the official “record” of the facts (in the form of documents and testimony). The second is for the hearing officer, after legal briefs have been filed, to reach a recommended decision for the tax commissioner.
If the hearing does not reach a decision in the taxpayer’s favor, the taxpayer can appeal the case to the Nebraska District Court. The District Court will schedule a hearing, which will be based on the evidentiary “record” of facts established at the department hearing. The district court will render a judgment (after legal briefs have been filed) based on the court’s own view of the proper result. From there, either party may appeal to the Court of Appeals or Supreme Court.
Successful Settlement Strategies
Successful settlements are not a matter of chance. You can’t expect the Department of Revenue to agree to a fair resolution, unless a strong defense is first presented that the department will recognize (as a matter of sound legal basis and litigation risk). So, while most of our cases settle, a number of steps must first be taken to lay in and position the proper legal and evidentiary groundwork for a successful settlement posture.
Beyond the Statutes
A winning tax defense position needs to recognize (and potentially defend against) a variety of overriding tax law principles that extend beyond the wording of the statute, regulation, or ruling. Legal “common law” doctrines, such as Substance Over Form, Step Transaction, Economic Substance, Sham Transaction, and Business Purpose, need to be understood (and planned for) at the time of the transaction and deployed or defended against in the Protest process.
Rules of the Game
Just as in any ongoing competition, the rules of the game must be known, understood, and deployed, when appropriate, to your advantage. These may include, for example, Rules of Evidence, Protection of Privileges, Burden of Persuasion, Rules of Construction, Taxpayer Rights, Due Process, Assessment Standards, Equitable Recoupment, Nexus, and Burden of Proof.
Avoiding Unauthorized Practice
The unauthorized practice of law by non-lawyers is an issue being taken seriously by state bar associations nationwide, as well as applicable judicial officials. In Nebraska, non-lawyers cannot take any action in a Nebraska tax defense that requires “the knowledge, judgment, or skill of a lawyer.” (NDR Reg. 33-008 and Neb. Sup. Court Rule 3-1003.) Based on this rule, the Department of Revenue has published guidance that states it will not allow non-lawyers to represent clients in formal hearings.
This really hit home recently when we were asked by a multistate company (headquartered outside Nebraska) to review a lengthy letter (essentially a legal brief) that had been sent to the Department of Revenue with little positive effect. This “brief” had been prepared by a non-lawyer and was very official looking, being filled with more than 30-plus legal citations and a lot of legal discussion. The problem was that the non-lawyer had missed the critical issue and hadn’t marshalled the critical facts needed to make the case.
Just as in other professions, these rules are in place to protect persons from those who try to deploy professional expertise and insights they don’t have (or may not be aware of). So, we urge caution by non-lawyers and companies alike.
Summary
To reach a favorable resolution of a state tax matter, a state and local tax professional must first demonstrate the strength of the taxpayer’s factual and legal position and then move ahead with the speed, clarity, and attitude consistent with a belief in that position. This requires a careful understanding of the relevant facts and legal issues before the audit, during the audit, and on appeal.
