tax, and property tax purposes. Classification may be challenged or become less clear when the buyer and seller agree to an election under Internal Revenue Code Section 336(e) or 338(h)(10) to treat a stock sale as an asset sale. This classification can affect (among other things): a) the valuation and depreciable life of personal property for property tax purposes; b) qualification of the transaction for Nebraska’s capital gains exclusion; and c) certain sales tax exemptions. Classification as Employee Versus Independent Contractor (Incentive, Sales & Withholding Tax) Classification of a person as an independent contractor or employee is a common question that businesses of all types must deal with. There are many tests to apply in making this distinction. For example, the IRS has announced a 20-factor test. The Nebraska Supreme Court has announced a 10-factor test. This reclassification can affect (among other things): a) the state and federal tax withholdings required for a person; b) sales taxation of items produced for your business by the person or firm; and c) inclusion of the person in a company’s Nebraska incentive new job and compensation calculations. Classification of Software Developers (Sales Tax) The Department of Revenue will reclassify custom software developed by outside firms as a taxable sale of software, unless the software development contract meets a three-factor test for the developers to be treated as “temporary employees” of the company for sales tax purposes. This three-factor test is contained in the Department of Revenue’s Rev. Rul. 1-02-1. If a company very precisely includes the three factors for temporary employees in its software development contract, and the contract does not contain various conf licting provisions, Nebraska sales tax will not apply. Taxation of Cloud Computing & Data Center Services (Sales Tax) The Department of Revenue has been reviewing how cloud computing and data center services are classified and has, in multiple instances, attempted to reclassify those transactions under various theories. First, the Department of Revenue has alleged that sales tax is due on a part of cloud computing or data center services, because those services are protected by certain levels of software security measures. In Nebraska, security services are taxable. Second, in certain instances, the Department of Revenue has alleged that companies receiving cloud computing services are really renting tangible personal property, which if that were the case would make the transaction taxable. Use of Step Transaction Doctrine to Treat Multiple Transactions as One The Department of Revenue, like many taxing agencies including the Internal Revenue Service, has increasingly been using the step transaction doctrine to reclassify a series of transactions as one transaction for tax purposes. This denies the business the expected result from the series of transactions and can result in significantly negative tax implications. The U.S. Tax Court has explained this doctrine as follows: “The step transaction doctrine generally applies in cases where a taxpayer seeks to get from point A to point D and does so stopping in between at points B and C. The whole purpose of the unnecessary stops is to achieve tax consequences differing from those which a direct path from A to Dwould have produced. In such a situation, courts are not bound by the twisted path taken by the taxpayer, and the intervening stops may be disregarded or rearranged.” The potential for reclassification under the Step Transaction Doctrine, like other doctrines such as Substance Over Form, 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 audit or appeal. Classification of Software as Tangible or Intangible Property (Incentives) Following the Nebraska Supreme Court decision in First Data Corp. v. Department of Revenue, the purchase of certain software may be classified and qualify for incentives under Nebraska’s incentive programs as the purchase of tangible property. To qualify, the license contract with the software provider must meet certain specific requirements, including that the business receives a nonexclusive license in the software. The Department of Revenue will still attempt to reclassify software from being qualified tangible property to ineligible intangible property. In so doing, it’s important to properly apply federal income tax law and properly respect key parts of the contract between the business and software provider. Classification of Business Activity (Tax & Incentives) Nebraska’s tax and incentive laws allow for benefits to certain types of qualified businesses. Nebraska law generally has specific definitions for the types of qualified businesses, which may not line up to the way the business views itself and which can result in a reclassification to a less favorable type of business. For example, to qualify as a manufacturer, very specific rules must be met regarding Designing the sale of a business as the sale of assets or the sale of stock can have several significant tax effects for sales tax, income tax, and property tax purposes. 19 nebraska society of cpas W W W . N E S C P A . O R G
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