Nebraska Supreme Court Declares IRC Section 965 Inclusion Not Eligible for Dividend Received Deduction

By: Michael Colavito, SALT Director

At a glance

• The main takeaway: The Nebraska Supreme Court concluded that repatriated income under Internal Revenue Code Section 965 was not a dividend, and thus not eligible for the state’s dividend received deduction.
• Assess the impact: The state income tax treatment on changes to the Internal Revenue Code are complex, because states can conform and decouple from federal law in varying ways.
• Take the next step: Aprio’s State and Local Tax (SALT) team can analyze and monitor state income tax treatment and assist your business with a review of its multistate tax filing positions with regard to foreign income.

Schedule a free consultation today to learn more!

The full story

The Nebraska Supreme Court recently issued an opinion in which upheld a District Court’s decision that the one-time income inclusion required under Internal Revenue Code (IRC) Section 965 is not eligible for the state’s income tax dividend received deduction.[1] While the decision resolves the treatment of the Section 965 inclusion under Nebraska law, the case could influence the treatment by other states on the same or similar types of income that a state has typically treated as qualifying as a dividend for purposes of a taxpayer being eligible for claiming a dividend received deduction. 

A closer look at IRC Section 965

In 2017, the enactment of the Tax Cuts and Jobs Act (TCJA) resulted in significant changes to the federal taxation of the earnings by U.S. corporations from a controlled foreign corporation (CFC). Included in those changes were modifications to income taxable as “Subpart F” with certain current earnings of a CFC being taxable as of January 1, 2018. In conjunction with this change, the TCJA included the implementation of IRC Section 965, which generally required a one-time income inclusion in 2017 of certain accumulated deferred foreign income of a CFC. This income inclusion has commonly been referred to as a “deemed repatriation” of income.

After the enactment of the TCJA, one of the immediate issues that needed to be addressed by taxpayers was the state treatment of the one-time Section 965 income inclusion. Many states permit a subtraction modification from taxable income for dividends received from foreign corporations. In the aftermath of the TCJA, several states issued guidance pertaining to whether taxpayers could claim a dividend received deduction for the IRC Section 965 income inclusion with many allowing a deduction.

Unpacking the case

Similar to other states, Nebraska’s corporate income tax law allows a subtraction from federal adjusted gross income or federal taxable income of a corporation for “dividends received or deemed to be received from corporations which are not subject to the Internal Revenue Code.”[2] The Nebraska Supreme Court ultimately held that the deemed repatriation of income under Section 965 did not qualify as “dividends . . . deemed to be received” under Nebraska law. The Court conceded that this phrase could be interpreted in two ways, either as:

1. Received income not otherwise considered a dividend but treated as a dividend by law; or
2. Income that is deemed received and would be treated as a dividend if it were received.

However, the court reasoned that Section 965 income inclusion is neither “nondividend income that is deemed to be dividends” nor “income deemed to be received that would be dividends if received.”

In addressing both potential readings of the phrase “dividends . . . deemed to be received,” the court first concluded that nothing in the language of Section 965 suggests that Congress intended the deemed income repatriation to be treated as a dividend. Instead, the court observed that “rather than stating that the inclusion should be taxed in the manner and at the rates applicable to dividends, Section 965 sets forth specific rates of taxation and other specific requirements for the income.” 

The court then referred to the U.S. Supreme Court’s consideration of how Section 965 operates in its June 2024 decision in Moore v. United States.[3] In Moore, the U.S. Supreme Court reasoned that Section 965 attributes undistributed income of U.S. controlled foreign corporations to their U.S. shareholders and then taxes those shareholders on that income. The Moore decision then provides that this results in Section 965 “operat[ing] in the same basic way as Congress’s longstanding taxation of partnerships, S corporations, and subpart F income.” 

With this in mind, the Nebraska court concluded that Section 965 does not operate in a manner whereby it deems shareholders to have received a distribution of retained earnings from CFCs (i.e., a dividend), but instead reflects pass-through treatment of earnings realized by CFCs that is attributed to the shareholders regardless of whether those earnings are distributed. Thus, the court concluded that Nebraska’s dividend received deduction does not apply to the Section 965 income inclusion. 

The bottom line

As noted above, several states treat the Section 965 income inclusion as being eligible for the state’s dividend received deduction. It’s too early to determine the impact the Nebraska Supreme Court decision may have on the treatment of “deemed” income inclusion provisions in other states. It’s possible that states could refer to the characterization of Section 965 income as pass-through income in disallowing a dividend received deduction, especially in light of such characterization as was observed in the Moore decision. 

In Nebraska, this decision may not just apply to Section 965 income, as the Nebraska Department of Revenue has published positions regarding Subpart F income and GILTI.[4] There may also be potential implications for state apportionment factor representation if the income, rather than being treated as a deductible dividend, is viewed instead as pass-through income. 

The state income tax treatment of changes to the Internal Revenue Code can be a complex area for state income taxation with states conforming and decoupling from federal law in varying ways. Aprio’s SALT team has experience analyzing and monitoring these types of issues, and we can assist your business with a review of its multistate tax filing positions with regard to foreign income. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.  

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[1] Precision Castparts Corp. v. Nebraska Dept. of Rev., 317 Neb. 481 (Neb. Sup. Ct., Aug. 30, 2024).
[2] Neb. Rev. Stat. § 77-2716(5).
[3] 144 S. Ct. 1680, 219 L. Ed. 2d 275 (2024).
[4] See Nebraska Revenue Ruling No. 24-21-1 (Feb. 17, 2021) and Nebraska Revenue Ruling No. 24-20-1 (Nov. 19, 2020).`