Supreme Court Decision Ensures More Nebraska M&A Transactions Can Rely with Confidence on Nebraska Special Capital Gains Tax Exclusion
On October 14, 2016, the Nebraska Supreme Court held a taxpayer was eligible for the special capital gains exclusion based on a plain reading of the statute and that the economic substance and sham transaction doctrines could not be used to disallow the Nebraska special capital gains exclusion.
The special capital gains exclusion generally allows a taxpayer to exclude the capital gain from the sale of stock for Nebraska state income tax purposes if the parties satisfied five different requirements:
• First, with limited exceptions, the stock being sold must have been acquired by the shareholder based on their employment with the corporation.
• Second, the corporation issuing the stock must, at the time of the first sale of the stock, have at least five shareholders.
• Third, at least two shareholders must be unrelated.
• Fourth, the unrelated shareholder or shareholder group must own at least ten percent of the capital stock of the corporation.
• Fifth, the shareholder must file a Form 4797 with the Nebraska Department of Revenue.
In Stewart v. Nebraska Department of Revenue, the Tax Commissioner disallowed a taxpayer’s special capital gain election because the taxpayer added additional shareholders only days before the sale of the corporation’s stock solely for purposes of meeting the five shareholder requirement under the statute. The Tax Commissioner claimed the addition of the new shareholders lacked “economic substance” and constituted a “sham transaction,” both of which are judicially created doctrines.
The Nebraska Supreme Court reversed the decision of the Tax Commissioner and allowed the capital gain exclusion because, based on a plain reading of the statute, the corporation was only required to have five shareholders at the time of the first sale or exchange, of which two must be unrelated and holding at least ten percent of the capital stock of the corporation. Because the taxpayer properly claimed the exclusion and the corporation met the requirements under statute, the taxpayer’s election was proper.
This decision is good news for Nebraska owners of corporate stock that are considering a stock sale. Many times, an owner will not know with certainty whether or not a stock sale will close. If the sale does not close, the owner may be uncomfortable transferring stock to unrelated shareholders, such as long-time employees or charity. The Supreme Court’s holding allows more flexibility in structuring transactions that qualify for Nebraska’s special capital gains exclusion.