In a decision that could have ramifications elsewhere, the Massachusetts Appellate Tax Board recently held that gains a non-resident realized on the sale of stock of a corporation he founded was subject to personal income tax under Massachusetts General Law Chapter 62, Section 5A as it was connected to his former employment in the Commonwealth. (See Welch v. Commissioner of Revenue, Mass. App. Tax Bd., C339531, 11/29/23).
General Laws c. 62, § 5A provides that [i]tems of gross income from sources within the commonwealth are items of gross income derived from or effectively connected with: (1) any trade or business, including any employment carried on by the taxpayer in the Commonwealth, whether or not the nonresident is actively engaged in a trade or business or employment in the commonwealth in the year in which the income is received. G.L. c. 62, § 5A (amended by St. 2003, c. 4, § 7); see also 830 CMR 62.5A.1(1)(a). The statute was amended by St. 2003, c. 4, § 7, broadly to define the phrase “gross income derived from or effectively connected with any trade or business” as follows: For purposes of this section, gross income derived from or effectively connected with any trade or business, including any employment, carried on by the taxpayer in the commonwealth shall mean the income that results from, is earned by, is credited to, accumulated for or otherwise attributable to either the taxpayer’s trade or business in the commonwealth in any year or part thereof, regardless of the year in which that income is actually received by the taxpayer and regardless of the taxpayer’s residence or domicile in the year it is received. It shall include, but not be limited to, gain from the sale of a business or of an interest in a business . . . . G.L. c. 62, § 5A (amended by St. 2003, c. 4, § 7). “While the amendment did not overturn the body of case law holding that a taxpayer personally must carry on the trade or business in Massachusetts that results in the income at issue, see, e.g., Commissioner of Revenue v. Dupee, 423 Mass. 617, 619 (1996),8 the carrying on of the trade or business is no longer limited to the year of the taxable event, thus broadening the timeframe during which the Board analyzes the connection between a taxpayer’s trade or business and the income at issue.” Id.
The question at issue in Welch was whether gains realized by a nonresident on the sale of stock in a corporation he founded was subjected to personal income tax in Massachusetts. Mr. Welch – a nonresident at the time he sold at a gain his shares of common stock in AcadiaSoft, Inc., a Delaware corporation, was found subject to personal income tax in Massachusetts pursuant to G.L. c. 62, § 5A. The predecessor of AcadiaSoft, Inc. originated in 2003, when a corporation by the same name was formed by Mr. Welch and first organized in Massachusetts. At the time, he was the sole stockholder. This company then merged into a Delaware corporation of the same name in 2009. Mr. Welch’s stock in this company was considered founder’s stock. In addition to being a Director at AcadiaSoft, Mr. Welch was considered an employee of AcadiaSoft, holding numerous responsibilities and positions at times, including CEO, President, Vice President, and Treasurer. In 2015, Mr. Welch testified he was forced to voluntarily resign, yet he retained the tile of CEO until the date of his resignation. In June of 2015, AcadiaSoft issued a contingent offer to repurchase all of Mr. Welch’s common stock. AcadiaSoft issued Mr. Welch a 2015 Form 1099-B indicating the sale of 97,334 shares of AcadiaSoft’s common stock disposed of on June 29, 2015, with proceeds reported as $4,744,759.96. The Form 1099-B reported no cost or other basis.
On April 16, 2016, Welch timely filed his 2015 Form 1 – Massachusetts Nonresident/Part-Year Resident Tax Return (“2015 Form 1”), which indicated April 30, 2015, as Welch’s last date of Massachusetts residency. Mr. Welch reported the sale of AcadiaSoft stock on Schedule D of the appellants’ 2015 Form 1 but excluded the $4,774,759.96 of gain from the sale of his AcadiaSoft shares as income not sourced to Massachusetts. Welch filed a joint Interest and Dividend Tax Return as a resident of New Hampshire for the period April 30, 2015 to December 31, 2015, reporting all interest and dividend income earned for this eight-month period (but not the gain on the sale of Mr. Welch’s AcadiaSoft stock) to New Hampshire, and paying $190 in New Hampshire taxes. The Commissioner issued a Notice of Intent to Assess to Welch for the tax year at issue on January 18, 2019, followed by a Revised Notice of Intent to Assess on February 26, 2019. The Commissioner issued a Notice of Assessment to the appellants for the tax year at issue on March 5, 2019, assessing $335,968.62 in tax, interest and penalties upon Welch, based upon the gain realized on his shares of common stock. Welch filed an abatement application for the tax year at issue on or about April 25, 2019.
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Ultimately, the Board ruled that the gain on the sale of Mr. Welch’s AcadiaSoft common stock was Massachusetts source income subject to taxation under G.L. c. 62, § 5A on the basis that the income was derived from the business of employment carried on by Mr. Welch in the Commonwealth. The Board’s ruling was based on several factors, including that until late 2014, Mr. Welch was actively engaged in the affairs of AcadiaSoft, a company both headquartered in Massachusetts and that filed Massachusetts corporate excise returns apportioning 100 percent of its income to Massachusetts. Further, during this same time period, Welch was a resident of Massachusetts, and sought no credit for taxes paid to other jurisdictions when filing their tax returns for 2003 through 2014. Further, Welch was not a passive investor in AcadiaSoft, but a founder whose continued employment with the company contributed to its value to the degree that the company wanted him to retain the title of CEO until his resignation in 2015 because of his status in the industry. Mr. Welch even correlated the timing of his resignation with his payout, further supporting the connection between his employment and the income from stock gain.
The Board’s decision emphasized the importance of the income’s provenance, not the tax character and timing of the income. For nonresidents, the income must be derived from a trade or business, including any employment, carried on in state regardless of whether the taxpayer is actively engaged in the trade/ business/ employment in the commonwealth in the year in which the income is ultimately received. While the regulation states that this rule “generally does not apply . . . to the sale of shares of stock in a C or S corporation, to the extent that the income from such gain is characterized for federal income tax purposes as capital gains,” it makes clear that “[s]uch gain may . . . give rise to Massachusetts source income if, for example, the gain is otherwise connected with the taxpayer’s conduct of a trade or business, including employment (as in a case where the stock is related to the taxpayer’s compensation for services).” 830 CMR 62.5A.1(3)(c)8. While Welch argued that he traveled extensively for work such that he was not engaged in business or trade in the Commonwealth, the Board was not persuaded. The Board found Welch presented no evidence to support his claims concerning his travels. To the contrary, the Board found that Welch did not file returns in any other jurisdiction or claim any credit for taxes paid to other jurisdictions.
An appeal to the Massachusetts Supreme Court is currently pending. In the meantime, those nonresidents who receive stock options related to their employment in Massachusetts should be wary when determining their taxable income. The Department of Revenue’s regulation requires nonresidents who derive income from the exercise of stock options to either allocate or apportion the income to Massachusetts.
While they may be able to argue the stock is passive income in most instances, the lynchpin on whether any income is subject to Massachusetts tax under G.L. c. 62, § 5A may turn on whether the taxpayer has filed returns or claimed credit for taxes paid in other jurisdictions.