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Nebraska's Below-the-Belt Decision to Audit "Above the Line"

The Nebraska Department of Revenue (Department) recently declared, by way of an article in a third-party newsletter, that it has the authority to “examine all aspects of a return, including federal items.” George Kilpatrick,

The Nebraska Department of Revenue (Department) recently declared, by way of an article in a third-party newsletter, that it has the authority to “examine all aspects of a return, including federal items.” George Kilpatrick, Nebraska Revenue Department’s Audit and Examination Powers Discussed, THE NEBRASKA CPA (Oct. 2012). While the article is aimed at personal income taxpayers, corporate taxpayers have good reason to be concerned because the statutory language relied on by the Department is applicable also to the corporate income tax.

The Department’s authority to audit federal return information purports to derive from three sources: the Nebraska Constitution; the Nebraska Revised Statutes; and a Nebraska Supreme Court case. Each of these sources provides simply that Nebraska tax statutes can and do rely on the federal income tax laws. The Department also relies on determinations made in other states regarding the scope of a state tax authority’s auditing power.

Importantly, the tax calculation has a definitional limit that the Department fails to note: both the individual and corporate income tax are imposed on “federal adjusted gross income” and “federal taxable income,” respectively, subject to a finite list of statutory modifications under Neb. Rev. Stat. Ann. §§ 77-2716, 77-2716.01, and 77-2734.01. The specific references to federal adjusted gross income and federal taxable income arguably should prevent the Department from deviating from a federal tax calculation.

The Nebraska Department of Revenue interestingly frames the issue as one where it would be a dereliction of its duty if it were not to audit above the line. Unfortunately, the article is short on rationale for such a conclusion.

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