The one-time IRC §965 income inclusion for untaxed foreign earnings generated by a controlled foreign corporation (“CFC”) is not eligible for deduction from Nebraska taxable income as a “deemed dividend” according to a recent Nebraska Supreme Court decision, Precision Castparts Corp. v Nebraska Dept. of Revenue, 317 Neb. 481 (2024).
Precision Castparts Corp. (“Taxpayer”), an aerospace component manufacturer, sought a declaratory order from the Nebraska Department of Revenue (“Department”) authorizing the company to amend its 2017 corporate income tax return by deducting IRC §965 income from its taxable base pursuant to the State’s dividends received deduction (“DRD”) statute, Neb. Rev. Stat. § 77-2716(5) (“There shall be subtracted from . . . federal taxable income dividends received or deemed to be received from corporations which are not subject to the Internal Revenue Code.”). The Department denied the Taxpayer’s request, reasoning “federal tax law makes ‘a distinction between a deemed dividend and a deemed inclusion’ . . .” A Nebraska district court agreed and held: “[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,’ and that it was ‘not enough that Congress merely deem[ed] it as income received. . . . Congress knows how to say a certain inclusion income is to be considered and treated as a dividend even when it is not . . .” The district court then “agreed with the Tax Commissioner’s conclusion that the Section 965 inclusions are income, but they do not qualify as ‘dividends . . . deemed to be received’ under [§ 77-2716(5)].”
On appeal to the Nebraska Supreme Court, the Taxpayer argued IRC §965 deems U.S. corporate shareholders to receive distributions from their CFCs from untaxed retained earnings. Prior to enactment of the Tax Cuts and Jobs Act in 2017, “earnings of CFCs were generally not taxed to shareholders unless and until they were distributed to shareholders” as dividends. Therefore, the automatic income inclusion under IRC §965 is a deemed dividend for purposes of Nebraska’s DRD statute according to the Taxpayer.
The Nebraska Supreme Court disagreed. Relying on the U.S. Supreme Court’s decision in Moore v. United States, the Court held: “Section 965 employs pass-through treatment to attribute earnings to shareholders without deeming a distribution to have been made to shareholders. We therefore conclude that income included in federal taxable income pursuant to Section 965 does not qualify for deduction as ‘dividends . . . deemed to be received’ under § 77-2716(5).”
Key Takeaways
The Nebraska Supreme Court’s narrow ruling in favor of the Department has broad implications for corporate taxpayers in Nebraska and beyond. For taxpayers operating within Nebraska, the precedent set by this decision is not necessarily limited to the IRC §965 inclusion and reinforces the Department’s position with respect to different types of Subpart F income (encompassing IRC §§951-965). For example, in Nebraska Revenue Ruling No. 24-21-1 (Feb. 17, 2021), the Department concludes “Subpart F income is not categorically a dividend or deemed dividend” and, thus, “[a]ny deduction for Subpart F income claimed as a dividend or deemed dividend … will [generally] be disallowed [with limited exceptions].” See also Nebraska General Information Letter No. 24-20-1 (Nov. 19, 2020) (“under Nebraska law, with the exception of . . . IRC §78 dividends attributed to GILTI, there is no exclusion for GILTI income as a foreign dividend or deemed foreign dividend.”). For taxpayers operating in states outside Nebraska, the Court’s reasoning in Precision Castparts is at odds with how many other states interpret their DRDs. This decision is a reminder to perform an internal review of your multistate tax profile to confirm foreign income is being appropriately treated across jurisdictions.
Contact the Authors: Drew Hemmings and Leah Regan
