the actions that the business performs upon the final product. This means that some businesses that view themselves as manufacturers may not be manufacturers for tax or incentive purposes, as the Departments of Revenue and/or Economic Development may attempt to reclassify the business as performing another activity. Defending against this reclassification requires a detailed understanding of the business model and precise explanation of the model to the Departments of Revenue and/or Economic Development. Classification as Compensation or Dividends (Incentives & Income Tax) Those who have worked on federal income tax audits and appeals are familiar with IRS efforts to reclassify dividends and reasonable compensation in closely held corporation situations. The same reclassification can be applied by the Nebraska Department of Revenue in addressing the amount of compensation for incentive job credits and in addressing compensation income tax deductions versus dividend distributions. Classification as Compensation or Dividends (Unemployment Tax) Classification of ownership distributions as wages for unemployment tax purposes illustrates another dividend versus compensation reclassification. The Nebraska Department of Labor (DOL) recently mailed a letter to all limited liability companies (LLCs) and limited liability partnerships (LLPs) in Nebraska, reminding them of their requirement to pay Nebraska unemployment tax on the distributions to LLC members and LLP partners that constitute wages for Nebraska unemployment tax purposes, resulting in a potential reclassification. Under a Nebraska DOL regulation, a distribution of a share of the profits to a member of an LLC or partner in an LLP will be reclassified as wages if one of three conditions are met: 1. The distribution exceeds the proportion of the total paid in capital investment of the LLC or LLP owned by the recipient. 2. The distribution is made based upon the number of hours, days, weeks, or months the individual performed services. 3. The distribution is made primarily based upon services performed for the LLC or LLP. Many LLCs and LLPs have not treated such distributions as wages, but the Nebraska DOL’s regulation effectively reclassifies the payments as wages—at least for Nebraska unemployment tax purposes. This highlights a common reclassification by taxing agencies— converting ownership distributions to wages and vice versa. To avoid this reclassification, the rules regarding distributions need to be understood and precisely applied to ensure that a payment will have its intended tax result. Classification as a Resident or Nonresident (Income Tax) While you may believe you have left Nebraska and become a Nebraska “nonresident,” the Nebraska Department of Revenue Nick Niemann and Matt Ottemann are partners with McGrath North Law Firm. As state and local tax and incentives attorneys, they collaborate with CPAs to help clients and companies evaluate, defend, and resolve tax matters and obtain various business expansion incentives. For more information, visit www.NebraskaStateTax.com and www.NebraskaIncentives.com. For a copy of their full publication, The Anatomy of Resolving State Tax Matters, or their Nebraska Business Expansion Decision Guide, visit their websites or contact Niemann or Ottemann at (402) 341-3070 or at nniemann@mcgrathnorth.com or mottemann@mcgrathnorth.com, respectively. aggressively applies its multifactor test to find otherwise and reclassify you as a Nebraska resident. It has taken several cases to court in recent years. Conclusion Avoiding each of these reclassifications by the Departments of Revenue, Economic Development, and Labor requires a thoughtful application of the facts of each transaction or business to a detailed understanding of the applicable law, whether that is statutory, regulatory, or case law. The first step is for an advisor to be sure that he or she understands the applicable facts, issues, and legal standards and the potential contentions that each department could make in attempting to reclassify. The second step is to ensure the legal documentation properly exists to support the intended result. BUILD YOUR CAREER HERE. We’re Hiring. Come see what all the noise is about. In a collaborative atmosphere of expertise and knowledge sharing With a team of professionals who value innovation, intelligence and integrity Support in finding your right work/life balance fzacpa.com 402.496.9100 I S S U E 4 , 2 0 2 2 20 nebraska cpas
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