A. History - The sales and use tax (usually referred to as just the sales tax) began in Nebraska in 1967. The following table shows the rate of the sales tax from 1967 to the present.

HISTORIC SALES TAX RATE

Source: Nebraska Department of Revenue

Although many changes have been made in the sales tax since 1967, one of the most significant was the 1983 elimination of the sales tax on food for home consumption. This exemption also eliminated the food sales tax credit. The food sales tax credit was a credit granted on the income tax form that was to approximate the amount a typical taxpayer paid in sales tax on groceries. The credit was a flat amount that reduced somewhat the regressive nature of the sales tax.

Other changes occurred in the early to mid 1980s when the sales tax was extended to include significantly more services than was the case previously. Included among the services that have been within the sales tax base since then are computer programming, warranty contracts, and utility payments. This period was probably the last time before 2002 that the sales tax base was significantly expanded.

Legislation enacted in 2002 and 2003 significantly broadened the sales tax to include more services. Added to the sales tax base at that time were building cleaning and maintenance, some animal services, pest control services, security and detective services, motor vehicle washing, waxing, and towing, installation changes, most repair services except for repairs of motor vehicles, and some construction labor. Legislation in 2005 exempted manufacturing machinery and equipment, beginning Jan. 1, 2006. Legislation in 2006 and 2007 eliminated all taxes on construction labor.

B. Base - In general: The Nebraska sales tax is levied on the retail sales of tangible personal property and some specifically listed services. (NEB. REV. STAT. Sec. 77-2702 to 22-2713.) Thus, by its basic definition, it does not apply to sales for resale, sales of intangible property, most services, or real estate. It does apply to admissions and approximately 75 other services according to the Federation of Tax Administrators 2004 survey. This number ranked Nebraska 10th among the 50 states and the District of Columbia, in the number of services taxed as of the 2004 survey date. Nebraska still ranks behind South Dakota and Iowa among the contiguous states.

The use tax is simply a compensating tax for goods bought outside the state, but used within the state. Any sales tax paid to another state is an offset, so if another state collects a sales tax on the purchase, there is no Nebraska use tax liability. Unlike the sales tax, the use tax is remitted by the purchaser (rather than the seller, since the seller is outside the state). Thus, as a practical enforcement matter, use tax revenue only arises from major auditable purchases by businesses.

Exemptions

The Department of Revenue publishes a Tax Expenditure Report every two years. The most recent report was released in October 2006 and may be found on the department's web site. The report is constructed based on affirmative statutory or regulatory exemptions, meaning that the definition of "exemption" for purposes of the report encompasses only transactions which are not taxed because something in the law creates an exemption. Transactions that are not subject to tax because they are not retail sales of tangible personal property, ie. sales of services or real estate, are not considered exemptions.

In the sales tax section, the Tax Expenditure Report has over 70 entries which total more than $3 billion in forgone sales tax revenue. Space will not permit showing and explaining all of these exemptions in this location, but we can combine and summarize some of this information.

(All dollar amounts assume a 5.5% state sales tax rate, local sales taxes are not included.)

Five-sixths of all sales tax exemptions are business inputs of some kind. Included in this category are sales for resale ($1.561 billion), ingredient and component parts ($753.1 million), agricultural products, feed, seed and chemicals ($398.1 million), energy used for irrigation and manufacturing ($178.1 million), and containers for shipping ($24.5 million). These exemptions total more than $2.5 billion, although more than half of that amount is sales for resale. In addition to this amount, $15.3 million of state sales taxes were retained by retailers as a collection fee, (this amount was cut dramatically in August 2002) and $40 million of state and local sales taxes were refunded to businesses under the Employment and Investment Growth Act in calendar year 2003.

The next largest category of exemption are the entity-based exemptions. Hospitals, educational institutions, churches, other charities, the state and most of its subdivisions are exempt from tax on their purchases and this amounts to $224 million. Next are equity-based exemptions, primarily groceries and apartment rentals costing $190.5 million and prescription drugs and medical equipment, costing $59.4 million in state revenue.

The next group deals with what is defined as "sales price" and "gross receipts" for sales tax purposes. Retailer coupons, motor vehicle and motorboat rebates, and trade-ins (primarily motor vehicle trade-ins) cost the tax base about $146 million. Some items are excluded from the sales tax because sales of the items are subject to another tax, like aircraft and motor vehicle fuel. These exemptions subtract $200 million from the sales tax base. Seller-based exemptions, like hospital room and food charges, dorm fees, and sales by PTOs and churches cost the state $66 million in sales tax revenue.

Interstate commerce exemptions, like sales of railroad rolling stock and repairs parts for common carriers chip away another $33 million. Agricultural and horticultural machinery and equipment exempts $12.9 million and manufacturing machinery and equipment, $15 million. Other exemptions, like for newspapers and lottery tickets are smaller.

Constitutional limitations

Enforcement of sales and use tax collection from mail order or Internet sales is an increasing source of revenue loss for the state. The U.S. Supreme Court case, National Bellas Hess v. Illinois Department of Revenue, 386 U.S. 761 (1967), prohibited states from requiring mail-order companies to collect state sales tax unless the company has a physical presence in the state beyond mere solicitation through the U.S. mail or telemarketing. This decision was affirmed in Quill Corporation v. North Dakota 504 U.S. 298, (1992) 112 S. CT. 1404, although the grounds for the decision were limited to Commerce Clause issues. While use tax could be theoretically collected from Nebraska purchasers in these cases, in most instances, it is nearly impossible to enforce.

Recently policymakers in Nebraska and most other states have become concerned about the growth of electronic commerce and the difficulty of collecting sales or use tax on goods sold over the Internet. In 2001, the Legislature and Governor enacted LB 172 to authorize negotiation of a multi-state streamlined or radically simplified sales and use tax system.

In 2003, the Legislature enacted LB 282. This bill ratified the Streamlined Sales and Use Tax Agreement, as adopted by a group of 35 "implementing states" November 12, 2002. Through ratification, the state is now authorized to participate in a multi-state sales tax collection system that offers hope that the states, working together, may be able to enforce their sales and use tax collection responsibilities on sellers located in other states. Such a breakthrough would go a long way toward "leveling the playing field" between in state and out-of-state retailers.

The agreement requires the use of uniform definitions for products including food, clothing and drugs, that states have treated differently for years. However, in adopting all the conforming changes in definitions, LB 282 made no changes in the Nebraska sales tax base. No transactions previously taxed have become exempt or vice versa due to the requirements of the Agreement. This is nothing short of remarkable under the circumstances. Many, if not most other states that adopt conforming legislation will have at least some change in what is taxed by that state.

The agreement, and the terms of LB 282 itself, place restrictions on the freedom the state has always had in making changes in the sales tax. Changes in the rate of tax, or the transactions covered by the tax may only be made at the beginning of a quarter after at least 60 days notice. Interpretations of the meaning of certain terms or administrative requirements of the agreement may be made by states collectively rather than by the Department of Revenue by rule and regulation. Nebraska must accept retailers licensed by another state as qualified to collect Nebraska sales tax. Restrictions like these trade the advantages of individual state policy for the advantages of interstate uniformity.

All in all, LB 282 represents the largest change, both statutory and regulatory, in Nebraska sales and use taxes since the adoption of the tax in 1967. As of this writing, 18 states have adopted legislation which brings their states into compliance with the requirements of the agreement. These states represent slightly more than 20 percent of the population of states with a sales tax. This meets the participation thresholds necessary for the agreement to become effective. The agreement became operative in these states, including Nebraska on Oct. 1, 2006.

Areas of controversy

Like most states, the sales tax base includes many business purchases. Goods purchased for resale and ingredient or component parts are to be excluded (NEB. REV. STAT. Section 77-2702.13 (2)(a)(I)), while business machinery and goods consumed in the manufacturing process are to be subject to the tax. The following cases help illustrate the difficulty of applying this distinction.

In Nucor Steel v. Herrington, 212 Neb. 310, 322 N.W.2d 647 (1982), the Nebraksa Supreme Court upheld a refund of use taxes paid by Nucor Steel for tax paid on the purchase of graphite electrodes used for melting scrap steel for refining into steel bars. While it was true that the electrodes were for delivering electricity to the scrap, the evidence was that the deterioration of the electrodes added carbon to the steel, an important step in refining steel. Therefore, the graphite remained within the finished product as an ingredient or component part.

In contrast, the Court upheld a use tax assessment against Nucor for tax paid on the purchase of refractory brick used to insulate the furnace for melting the scrap in Nucor Steel v. Leuenberger, 233 Neb. 863, 448 N.W.2d 909 (1989). The tax was upheld even though the refractory brick deteriorated into the slag, scale and bag dust that was later sold as a byproduct. For the Court, the critical distinction was that the graphite in the electrodes was an essential element of the primary product, steel, while the refractory brick was an incidental ingredient to a byproduct. Refractory brick used for making steel or cement was later excluded from the definition of retail sale, and therefore exempted from tax by the provisions of NEB. REV. STAT. Section 77-2702.13. LB 1085 (2002) repealed this exemption, effective October 1, 2002.

In Lackawanna Leather Co. v. Nebraska Department of Revenue, 259 Neb. 100. 608 N.W. 2d 177 (2000), the Nebraska Supreme Court reversed the district court and rejected a requested refund of use taxes paid for various chemical solvents used to carry dye for coloring finished leather. The Court began its analysis by citing the regulations of the Department of Revenue that provide that an ingredient or component part physically or chemically enter into and remain a part of the finished product and must be an essential ingredient or component part of the finished product (316 Neb. Admin. Code, ch. 1, section 023.).

The evidence was that the solvents enter the leather, carrying the dye, and then most of it evaporates leaving only trace amounts in the finished product. Therefore, the Department asserted that the solvent itself was not an essential ingredient or component part even though the company could have purchased the dye and the solvents in one unit and the entire purchase would have been exempt.

The company asserted that this case was controlled by Vulcraft v. Balka, 5 Neb. App. 85, 555 N.W.2d 344 (1996), where the Nebraska Court of Appeals held that processing oils which coated and lubricated the steel bars during processing and remained on the finished product were exempt from sales and use tax. The Court of Appeals in that case held that the processing oils served two roles. First, lubrication of the steel bars during processing; and second, protecting them from corrosion until a later protectant was applied. Therefore, the processing oils are essential to the manufacture of the product and are exempt.

The Nebraska Supreme Court held that the Court of Appeals interpreted the ingredient or component part exception too broadly in the Vulcraft case. Even though the processing oils remained on the steel bars after processing and were essential to the manufacturing process, they were not essential ingredient or component parts of the finished product.

Likewise, the solvents used to carry dye to finished leather products are not essential ingredient or component parts of the finished product.

Another important issue with regard to the sales and use tax base is the taxation of labor applied to tangible personal property or incorporated into real estate. Under Nebraska law, materials purchased by contractors for the purpose of constructing improvements to real property may be considered retail sales to the contractor that are subject to sales tax at the location purchased or the building site if delivered. Such contractors may also elect to be treated as retailers and charge sales taxes on the full price charged to any purchaser. Contractors may also do both by maintaining a tax-free retail inventory and paying use tax on any inventory withdrawn for annexation to real estate. (NEB. REV. STAT. Section 77-2702.05.)

Most labor and services performed in connection with the sale of tangible personal property are considered part of the sales price and subject to the tax including warranties, rustproofing, and or other similar service. (NEB. REV. STAT. Section 77-2702.07 (a).) Consequently, the cost of transportation is a taxable component of the cost of tangible personal property. This was recently affirmed in the case of Affiliated Foods Cooperative v. State of Nebraska, 259 Neb. 549, 611 N.W.2d 105 (2000) where the Nebraska Supreme Court held that postage applied to fliers printed and mailed by an association at the direction of its member grocery stores to potential grocery store customers was taxable to the member stores.

C. Rate - The state sales tax rate is 5.5%. (NEB. REV. STAT. Section 77-2701.02.) Cities have an option to levy up to a 1.5% sales tax on retail sales within the city. The base, or transactions taxed, is identical. There must be a majority vote of the voters to approve the tax and the tax is collected by the Revenue Department and remitted to the proper city, less a three percent fee. The fee is deposited in the Municipal Equalization Fund for distribution to municipalities with below average valuation per capita. (NEB. REV. STAT. Section 77-27,142 through 77-27,148.)

Counties may also levy a local sales tax of up to 1.5% in areas outside any city with a local sales tax for purposes of funding joint public safety services together with cities and/or fire districts. Counties were granted this authority effective July 1, 1998, but as of this writing only Dakota County has used this authority. Exercise of this authority by a county also requires approval by the majority of those voting at an election.

D. Administration and Disposition - The sales tax is administered by the Nebraska Department of Revenue. Both the state and local tax is collected by the retailer and remitted to the state. Retailers retain 2.5% of the first $3,000 of sales tax remitted to the state each month as a collection fee. In the case of sales tax due on the sale or long-term lease of a motor vehicle required to be registered, it is collected by the county where registered at that time. Even the city sales tax is collected by the state and distributed back to the cities, less a three percent fee. All state sales and use tax revenue, except on sales or long-term leases of motor vehicles, is deposited in the General Fund. The sales tax on motor vehicles, attributable to a five percent state sales tax rate is deposited in the Highway Trust Fund and expended to build, repair, or maintain state or local roads and bridges. Any revenue attributable to a sales tax rate in excess of five percent is deposited in the Highway Allocation Fund and distributed equally between cities and counties for their road and street needs. (Sec. 77-27,132).

E. Enforcement - Sales taxes, state and local are to be returned to the Department of Revenue by the 25th of the month following the month in which the sales are made less the collection fee. Less frequent returns may be made if the retailer collects less than $300 of sales tax each year. (NEB. REV. STAT. Section 77-2708.) If there is a dispute over the sales tax to be remitted or any use tax owed, a claim for a refund must be filed within three years of the filing of the return or within 60 days of a final determination of liability by the Department. Any claim must be allowed or disallowed by the Tax Commissioner within 180 days of the filing of the claim or the claim is deemed allowed. Unless appealed, the ruling of the Tax Commissioner on any claim is final 30 days after notice is mailed to the claimant. Any interest is paid to the taxpayer at the same rate interest accrues on delinquent state taxes, a floating rate that is two percent higher than the treasury bill rate. (NEB. REV. STAT. Section 77-2708.)

The Tax Commissioner may make a deficiency assessment within three years of the date the return was filed. Any deficiency is to be assessed along with a penalty of 10 percent of the deficiency or $25, whichever is higher and interest at the floating rate discussed earlier. If fraud is alleged, the penalty is to be 25 percent or $50, whichever is higher.

A request for a redetermination of the deficiency must be filed within 30 days of the deficiency assessment and the taxpayer may request an oral hearing. The decision of the Tax Commissioner regarding a redetermination is final 30 days after notice of the decision is mailed unless appealed to the district court. (NEB. REV. STAT. Section 77-2709.)

Decisions of the Tax Commissioner both on claims for refund and deficiency determinations may be appealed to the district court of Lancaster County or the district court where the taxpayer resides. (NEB. REV. STAT. Section 77-2798.) Willful or fraudulent failure to remit sales taxes or pay use taxes is a Class IV Felony while negligent or other failure to pay is a Class IV Misdemeanor. (NEB. REV. STAT. Section 77-2713.)