The Taxonomy of Ownership and Distribution under the Nebraska Advantage Research and Development Act

Partners, members, shareholders, and beneficiaries represent the individual or entity owners of pass-through businesses who receive distributed shares of Nebraska R&D tax credits based on their ownership percentages. While the originating business entity may claim the credit as refundable, these specific recipients must utilize the credit as a nonrefundable offset against their Nebraska income tax liability. 1

Theoretical and Statutory Foundations of Research Tax Credits in Nebraska

The Nebraska Advantage Research and Development Act, administered by the Nebraska Department of Revenue, is a primary economic instrument designed to reward business firms for qualified research expenditures conducted within the state. 3 This legislative framework, primarily codified under Nebraska Revised Statutes § 77-5801 through § 77-5807, creates a symbiotic relationship with federal tax law by leveraging the definitions and calculation methods established in the Internal Revenue Code (IRC). 4 Specifically, the Act utilizes IRC § 174 to define research and experimental activities and IRC § 41 to determine the base amount and calculation of the credit. 3 This alignment ensures that businesses operating in Nebraska can maintain consistency between their federal and state tax compliance efforts, reducing the administrative burden often associated with multi-jurisdictional tax incentives. 7

The Act was enacted in 2006 with the explicit intent of fostering innovation in high-growth sectors such as agriculture, manufacturing, and technology. 3 By providing a refundable credit at the entity level, Nebraska positioned itself as a particularly attractive destination for startups and loss-making entities that may not have immediate income tax liability but require liquidity to sustain ongoing research operations. 3 The credit remains available for tax years beginning on or before December 31, 2033, providing a long-term horizon for corporate strategic planning. 3

Defining the Recipient: Partner, Member, Shareholder, and Beneficiary

In the landscape of modern business organizations, many entities are structured as pass-throughs, where the tax characteristics of the business flow directly to the owners. 8 For the Nebraska R&D tax credit to function effectively within this structure, the law must clearly define who is eligible to receive these benefits when the business itself is not a tax-paying C-corporation. 1

The term partner refers to a person or entity holding an interest in a partnership. 8 Under Nebraska law, a partnership includes any entity treated as such for federal income tax purposes, encompassing general partnerships, limited partnerships, and certain limited liability partnerships. 8 When a partnership incurs qualified research expenses in Nebraska, the resulting tax credit is distributed to the partners. 11 The mechanics of this distribution are governed by the partnership agreement, but for tax purposes, the credits must be allocated in the same manner and proportion as the partnership reports its income or loss. 2

A member is the equivalent of a partner within the context of a Limited Liability Company (LLC). 1 Nebraska revenue guidance treats LLC members as the ultimate recipients of distributed credits unless the LLC has elected to be taxed as a corporation. 8 This classification is critical because LLCs have become the preferred vehicle for research-intensive startups due to their structural flexibility and the liability protections they afford to their members. 3

The term shareholder applies to the owners of a Subchapter S corporation. 10 Unlike C-corporations, S-corporations do not pay corporate income tax; instead, they pass their tax attributes through to their shareholders. 9 Nebraska law requires that R&D credits be distributed to shareholders pro rata, based on their ownership interest in the corporation during the year the credit was earned. 10

A beneficiary is an individual or entity with a present or future interest in an estate or trust. 16 Fiduciaries, such as estates or trusts, can also qualify for the Nebraska R&D credit if they carry on qualifying business activities. 18 Any credit earned by the fiduciary that is not used to offset its own tax liability is distributed to the beneficiaries in the same proportion as the income is distributed. 10 This ensures that even in complex estate planning or trust arrangements, the incentive to conduct research remains intact. 19

The Mechanics of the Nebraska R&D Tax Credit

The calculation of the Nebraska R&D credit is essentially a two-step process that begins with the federal credit allowed under IRC § 41. 3 Because the federal credit is calculated on a national basis, businesses must first determine the portion of the federal credit that is attributable to research activities conducted within Nebraska. 2 This is achieved through specific apportionment rules that look at the location of the qualified research expenditures (QREs). 3

Standard and Enhanced Credit Rates

The Nebraska Advantage Research and Development Act provides for two distinct credit rates based on the location and nature of the research activities. 4 The standard rate is 15% of the federal credit allowed for research performed in Nebraska. 3 This applies to most off-campus research conducted by private firms. 3

However, the state offers a significant “university bonus” to encourage collaboration with Nebraska’s higher education system. 3 If the research or experimental activities take place on the campus of a Nebraska college or university, or at a facility in the state owned by such an institution, the credit rate is increased to 35% of the federal credit. 4 This enhanced rate is a powerful tool for sectors like biotechnology and advanced agriculture, which often require the specialized equipment and expertise found in academic settings. 3

The timeframes for claiming these credits also differ. 3 The standard 15% credit can be claimed for the first tax year it is claimed and for the following 20 tax years, provided the business firm continues to earn the federal credit. 6 The enhanced 35% credit is more concentrated, allowed for the first tax year and the following four tax years, provided the on-campus activity continues. 4

Determining Qualified Research Expenditures (QREs)

The Nebraska statute leverages the federal definition of QREs, which generally includes three categories of expenses: wages, supplies, and contract research. 3 For an expense to qualify for the Nebraska credit, it must meet the federal “Four-Part Test” established under IRC § 41(d). 5

1. Permitted Purpose: The research must be intended to create a new or improve an existing business component, focusing on functionality, performance, reliability, or quality. 23
2. Elimination of Uncertainty: The activity must be intended to discover information to eliminate uncertainty regarding the capability or method for developing or improving a business component. 5
3. Process of Experimentation: The research must involve a systematic process of evaluating one or more alternatives through modeling, simulation, or trial and error. 23
4. Technological in Nature: The research must fundamentally rely on the principles of physical or biological science, engineering, or computer science. 5

In addition to these federal requirements, Nebraska imposes a critical state-specific mandate: all business firms claiming the credit must timely and electronically verify the work eligibility status of all employees hired in Nebraska during the tax year for which the credit is claimed. 6 This verification is performed through the federal E-Verify system. 3 Failure to comply with the E-Verify requirement can result in the denial of the credit, making it a cornerstone of local state revenue office guidance. 5

Apportionment and Multi-State Business Operations

For businesses that operate in multiple states, the calculation of the Nebraska R&D credit requires a precise determination of the activities occurring within the state’s borders. 2 The Nebraska Department of Revenue provides two primary methods for this apportionment on Form 3800N Worksheet RD. 2

Method I: Property and Payroll Factors

Method I utilizes a ratio based on the physical and human capital deployed in Nebraska versus the company’s total operations. 2 This method is often preferred by larger corporations with established physical footprints in multiple jurisdictions. 2

The formula involves calculating a Nebraska property factor and a Nebraska payroll factor. 2 These factors are then averaged to create an apportionment percentage. 2 If the business is claiming the enhanced university credit, it must further bifurcate its Nebraska factors between off-campus and on-campus activities to apply the correct 15% or 35% rates. 2

$$Apportionment \% = \frac{\left( \frac{Property_{NE}}{Property_{Total}} + \frac{Payroll_{NE}}{Payroll_{Total}} \right)}{2}$$

2

Method II: Expenditure-Based Apportionment

Method II is more direct and is frequently used by smaller firms or those whose research activities are highly localized. 2 Under this method, the business simply divides the amount expended in research and experimental activities in Nebraska by the total amount expended in such activities everywhere. 2 This ratio is then multiplied by the total federal credit allowed to determine the Nebraska portion of the federal credit. 2

Gross Receipts and Base Amount Considerations

Nebraska follows federal startup rules for businesses that do not have a history of gross receipts. 3 If a business has no prior gross receipts, the base amount (the threshold above which research spending generates a credit) defaults to 50% of the current-year QREs. 3 This federal rule, adopted by Nebraska, ensures that new companies can begin earning credits immediately upon starting their research operations. 3

The Bifurcation of Refundability: Entity Level vs. Recipient Level

One of the most complex aspects of Nebraska’s R&D tax credit guidance is the “character change” that occurs when a credit is distributed from an entity to its owners. 1 This distinction is vital for understanding the true economic value of the credit for different types of stakeholders. 24

Entity-Level Refundability

At the entity level, the Nebraska R&D tax credit is fully refundable. 1 This means that a business firm (such as a C-corporation) can use the credit to obtain a direct refund of state sales and use taxes paid, or it can claim it as a refundable income tax credit. 1 If the credit amount exceeds the taxpayer’s income tax liability, the state issues a check for the difference. 3 This provides immediate liquidity, which is particularly beneficial for startups that are often in a loss position during their early, research-intensive years. 3

Recipient-Level Non-Refundability

However, when the credit is distributed to a partner, member, shareholder, or beneficiary, it loses its refundable character. 2 According to the instructions for Form 3800N Worksheet RD, “The credit is a nonrefundable credit in the hands of the recipient and may only be used against the recipient’s Nebraska income tax liability.” 2

This creates a significant strategic divide. 2 While a partnership might earn a $50,000 credit that is technically “refundable,” the partners who receive that credit cannot get a refund if their personal Nebraska tax liability is only $10,000. 1 They can only use the credit to wipe out their $10,000 liability. 1 Any unused portion of the credit in the hands of the recipient may be carried forward, but it will never result in a cash payment from the state. 1

Strategic Election: Sales Tax Refunds

To mitigate the impact of non-refundability for pass-through owners, Nebraska law allows the entity to use the credit to obtain a refund of state sales and use taxes paid before distributing the remaining credit to owners. 1 The entity can file quarterly claims for refunds of sales taxes paid directly by the taxpayer or indirectly through a contractor on building materials. 2 By taking the refund at the entity level, the business secures cash that can be used for operations, which is often more valuable than a nonrefundable income tax credit for the individual owners. 1

Local State Revenue Office Guidance: Filing and Compliance

The Nebraska Department of Revenue (DOR) provides specific guidance for the filing and documentation of R&D credits. 6 No prior application or registration is required to claim the credit; instead, it is claimed annually on the business’s tax return. 6

Required Forms and Documentation

The filing package for the Nebraska R&D credit typically includes several key documents. 2

1. Form 3800N Worksheet RD: This is where the actual calculation of the credit occurs, including the apportionment of federal expenses to Nebraska and the bifurcation of standard vs. enhanced activities. 2
2. Form 3800N: The Nebraska Incentives Credit Computation form. 18 This form summarizes all credits claimed by the taxpayer and ensures they are applied in the correct statutory order. 24
3. Nebraska Schedule K-1N: For pass-through entities, this form notifies each partner, member, shareholder, or beneficiary of their specific share of the distributed credit. 2
4. Federal Form 6765: A copy of the federal R&D credit form must be attached to the state return to provide the foundation for the Nebraska calculation. 3

Reporting for Distributed Credits

Recipients of distributed credits have additional reporting requirements. 2 On Form 3800N, these recipients must complete Section E (or Line 21/23 depending on the year of the form) to identify the distributing entity. 18 This includes providing the name, address, and Nebraska ID number of the partnership, S-corp, or trust that earned the credit, as well as the year the credit was earned and the specific incentive program (in this case, “Nebraska Advantage Research and Development Act”). 18

Order of Credit Utilization

Nebraska law mandates a specific order in which nonrefundable credits must be used to offset income tax liability. 24 This ordering is designed to ensure that credits with shorter expiration windows are used first. 24

Economic Performance and Audit Insights

The Nebraska Advantage Research and Development Act has been subject to rigorous review by the Nebraska Legislature and the Department of Revenue. 7 These reviews provide valuable statistical data on the program’s reach and effectiveness. 7

Program Participation and Award Data

Between 2006 and 2020, 460 companies participated in the R&D program, earning a total of $72.3 million in tax credits. 7 Of this amount, $67.7 million was utilized by the end of the 2020 tax year, representing a usage rate of approximately 93.7%. 7 This high utilization rate indicates that the program is well-aligned with the needs of the business community. 7

The high-tech sector, defined by statutory criteria, represents a significant portion of the program’s beneficiaries, receiving nearly a quarter of all awarded credits. 7 This highlights the program’s role in supporting Nebraska’s “Silicon Prairie” ambitions. 7

Audit Findings and Compliance Costs

A performance audit of the R&D Act noted that while the state program is efficient, the federal IRC § 41 program carries high compliance costs for businesses due to its complex documentation requirements. 7 However, once a business has navigated the federal qualification process, claiming the Nebraska credit is relatively straightforward. 7

One significant audit finding was the fiscal performance of the program. 7 While the Legislature initially estimated an annual cost of $5 million, the actual usage has exceeded this in recent years, with over $10 million in credits used in 2020 alone. 7 This reflects the growing intensity of research activities within the state, particularly in the agricultural technology sector. 3

Detailed Example: Calculation and Distribution for a Multi-Owner Startup

To illustrate the interplay between these laws, consider the case of “AgriTech Solutions LLC,” a Nebraska-based biotechnology firm. AgriTech is organized as a partnership for tax purposes and has three owners:

1. Partner A: A Nebraska resident individual (40% owner).
2. Member B: A venture capital firm organized as an LLC (40% owner).
3. Beneficiary C: A family trust established for the founder’s children (20% owner).

Step 1: Incurring QREs and Federal Credit Calculation

In 2024, AgriTech Solutions conducts research into drought-resistant seed coatings. 3 They hire ten new researchers, all of whom are verified through E-Verify. 6

• Total Nebraska QREs: $2,000,000.
• Off-Campus (AgriTech’s Lab): $1,500,000.
• On-Campus (University of Nebraska Lab): $500,000. 22

The firm calculates its federal R&D credit using IRS Form 6765. 3 For this example, assume the federal credit allowed is 10% of total QREs, or $200,000. 3

Step 2: Nebraska Credit Computation (Worksheet RD)

AgriTech must now calculate its Nebraska credit using the state rates. 2

1. Enhanced Credit (University):

• Federal portion for on-campus research: $50,000 (10% of $500,000).
• Nebraska rate: 35%. 4
• Enhanced Credit Amount: $50,000 $\times$ 0.35 = $17,500. 3

1. Standard Credit (Off-Campus):

• Federal portion for off-campus research: $150,000 (10% of $1,500,000).
• Nebraska rate: 15%. 3
• Standard Credit Amount: $150,000 $\times$ 0.15 = $22,500. 3

Total Nebraska R&D Credit: $17,500 + $22,500 = $40,000. 3

Step 3: Distribution and characters of the credit

AgriTech Solutions LLC has a choice. 1 It can claim the $40,000 as a refund of sales and use taxes paid by the company during the year. 1 If it paid $30,000 in sales tax on lab equipment, it could get a $30,000 check from the state and distribute the remaining $10,000 to the owners. 1

However, if they choose to distribute the entire $40,000, they must do so according to ownership percentages. 2

Step 4: Individual Owner Utilization

• Partner A has a 2024 Nebraska income tax liability of $10,000. They use $10,000 of their credit to reduce their tax to zero. 1 The remaining $6,000 is nonrefundable and is carried forward to 2025. 23
• Member B (the VC firm) has a Nebraska tax liability of $25,000. They use the full $16,000 to reduce their tax to $9,000. 18
• Beneficiary C (the Trust) distributes all its income to the beneficiaries. The $8,000 credit is passed through to the individual children based on their share of trust income. 10

The University Nexus: Revenue Ruling 29-10-2

The enhanced 35% credit for university-based research is governed by specific regulatory interpretations that distinguish it from the standard credit. 22 Revenue Ruling 29-10-2 provides the definitive guidance on what constitutes a “college or university” and where the research must physically occur. 22

Geographic Requirements

The ruling clarifies that the phrase “in this state” refers to the location of the campus or facility, not the college or university itself. 22 This means that a business firm could potentially qualify for the 35% credit if it conducts research on the Omaha campus of an out-of-state university, provided that campus is located within Nebraska. 22 Conversely, research performed at an out-of-state branch of a Nebraska university would only qualify for the standard 15% rate (or potentially no credit at all if not apportioned to Nebraska activities). 3

Institutional Definition

For the purposes of the Act, a “college or university” is an institution of higher learning that offers courses of study resulting in a bachelor’s, vocational, associate, technical, or professional degree, or higher. 22 This broad definition includes community colleges and technical institutes, provided they are located in Nebraska and the research is conducted at their facilities. 22

The Multi-Year Claim Period for Enhanced Research

The enhanced credit has a shorter “tail” than the standard credit. 4 While the standard credit can be claimed for 20 years, the 35% rate is allowed for the first year it is claimed and for the four tax years immediately following. 6 This is intended to encourage intensive, short-to-medium-term collaboration projects. 22 If a business continues the research on campus after the five-year window, it may still qualify for the standard 15% rate for the remainder of the 20-year eligibility period. 6

Labor Eligibility and the E-Verify Mandate

A unique feature of Nebraska’s tax incentive landscape is the mandatory use of the E-Verify system. 6 On and after October 1, 2009, all business firms claiming the R&D tax credit must timely and electronically verify the work eligibility status of all employees hired in Nebraska during the tax year for which the credit is claimed. 6

Scope of the Mandate

The requirement applies to all new hires, regardless of whether they are directly involved in research activities. 6 If a company hires a new receptionist in their Nebraska office and fails to run them through E-Verify, the entire R&D credit for the year may be jeopardized. 5 Employees hired before October 1, 2009, are grandfathered in and do not need to be verified. 6

Compliance and Audits

During a Department of Revenue audit, the taxpayer must provide “E-Verify logs” or other documentation showing that each new hire was processed through the system within the required timeframe (typically within three days of hire). 3 This procedural requirement underscores the dual purpose of the R&D Act: to stimulate innovation and to ensure compliance with federal and state labor eligibility laws. 3

Comparative Analysis: Nebraska vs. Neighboring States

Nebraska operates in a competitive regional environment, where neighboring states also offer R&D incentives. 7 A 2021 performance audit compared Nebraska’s R&D tax climate to Iowa, Kansas, Missouri, and Colorado. 7

According to the Tax Foundation, Nebraska’s overall tax climate was rated as the most competitive for “new” R&D companies among its six neighboring states. 7 For “mature” R&D companies, Nebraska was rated third. 7 This distinction highlights the value of the refundability feature, which disproportionately benefits new companies that are not yet profitable. 3

Pass-Through Entity Tax (PTET) and its Impact on R&D Credits

The introduction of the Pass-Through Entity Tax (PTET) in Nebraska has introduced a new layer of complexity for partners and shareholders. 8 PTET allows a partnership or S-corporation to elect to pay state income tax at the entity level, effectively bypassing the federal $10,000 cap on state and local tax (SALT) deductions. 9

Interaction with R&D Credits

When an entity makes the PTET election, it becomes the taxpayer for Nebraska income tax purposes. 8 The business can then use its R&D credits to reduce its PTET liability. 27 This effectively transforms the “nonrefundable” credit (which would normally go to the owners) into an entity-level offset. 9

For the owners, the benefit of the R&D credit is realized through the PTET mechanism. 9 The entity pays less tax because of the R&D credit, and the owners still receive their share of the federal deduction for state taxes paid. 9 Furthermore, owners receive a refundable credit on their personal returns for their share of the PTET paid by the entity. 8

Conclusion: The Long-Term Value of the R&D Credit in Nebraska

The Nebraska Advantage Research and Development Act remains a vital component of the state’s economic development strategy. 3 By providing a clear path for partners, members, shareholders, and beneficiaries to benefit from the innovation occurring within their businesses, the state fosters a culture of continuous improvement. 3

The key for taxpayers is to understand the “refundability pivot”—knowing when to claim a refund at the entity level versus when to distribute a nonrefundable credit to owners. 1 As the state moves toward lower income tax rates and broader participation through the PTET election, the R&D credit will continue to serve as a critical offset, ensuring that Nebraska remains a competitive hub for high-tech, agricultural, and manufacturing innovation through 2033 and beyond. 3

Final compliance relies heavily on the diligent use of the E-Verify system and the rigorous documentation of research activities as defined by the federal four-part test. 6 By maintaining high standards of reporting and leveraging university partnerships where possible, Nebraska businesses can maximize their return on investment in the state’s future. 3

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