Nebraska Department of Revenue v. Loewenstein

Background

A Nebraska resident who owns shares in two mutual funds (short-term government and Treasury trusts) challenged Nebraska’s tax on interest the funds earned from repurchase agreements (“repos”) that involved federal securities. The funds received cash in exchange for temporarily taking federal securities on their records, and later were repaid the cash plus an agreed-upon amount the funds called “interest.” Nebraska exempted direct interest on U.S. government obligations but taxed the income distributed by the funds. Lower courts ruled for the investor, but Nebraska asked the Supreme Court to resolve conflicting state and lower-court rulings.

Reasoning

The central question was whether the income the funds received from these repo transactions was legally “interest on” U.S. government obligations or instead interest on loans the funds made to private sellers. The Court examined how repos worked and noted the repo interest rate was set by market rates for the loan term, not by the government securities’ coupon or discount. The Court found the securities functioned as collateral, the funds could liquidate collateral on default, and margin and substitution rules fit a lender–borrower relationship. For those reasons, the Court concluded the income was interest on loans to private parties, not interest on U.S. obligations, and therefore Nebraska’s tax did not violate the federal exemption statute.

Real world impact

The decision means States may tax income that money-market trusts and similar funds earn from repos using federal securities. It does not change how repos should be treated under bankruptcy, banking, or securities law, and it leaves the exemption for direct holders of U.S. obligations intact.