Massachusetts Tax Board Rules that Nonresident is Subject to Tax on Gain from Stock Sale

By: Michael Colavito, SALT Director

At a glance

• The main takeaway: A recent Massachusetts case ruled that the founder, and former executive, of a corporation was subject to income tax on the gain from the sale of stock, even though he was a nonresident at the time of the sale. 
• Assess the impact: Addressing the multistate income tax consequences from the sale of an interest in a corporation or pass-through entity is becoming more complicated, and close attention needs to be paid to each state’s rules and interpretive guidance.   
• Take the next step: Aprio’s State and Local Tax (SALT) team can assist you by recommending potential structuring alternatives to minimize your multistate tax liabilities and ensure you remain in compliance with your multistate income tax obligations.

Schedule a free consultation today to learn more!

The full story:

When an individual recognizes gain of the sale of stock in a corporation, the typical result for state income tax purposes has generally been that the individual is only subject to income tax on that income in their state of residence. However, this may not always be the case, as reflected in a recent decision issued by the Massachusetts Appellate Tax Board.¹

It is worth noting, as described below, that Massachusetts’ income tax laws have more expansive rules for taxing nonresidents, so while this decision may be an outlier, the tax treatment of nonresidents that sell their business is a topic that has the attention of states. 

A closer look at the case

This case concerns the taxation of significant gain recognized by a nonresident taxpayer in 2015 from the sale of stock in a corporation he founded in 2003. The sale of his stock coincided with his resignation as an employee of the corporation. Throughout his tenure, the taxpayer was employed in various executive positions, including president, treasurer, and CEO. The taxpayer was initially the sole director of the corporation in 2003 and remained a member of the board through 2015. He was involved in key aspects of the corporation’s operations, including:

• Hiring personnel,
• Briefing on legal claims,
• Presenting business plans,
• Seeking equity financing,
• Reporting on the status of key sales prospects, and
• Providing reports on the results of operations and cash flow. 

The taxpayer described himself as the “chief evangelist” and “chief cook and bottle washer” of the company. He also described the company as “his baby” and stated that “I was the product and the product was me.” After a falling out with other members of the board in 2014, the taxpayer eventually agreed to resign as CEO after the company offered to buy-out his stock. From the corporation’s inception through 2015, the corporation’s headquarters was in Massachusetts, and from 2003 to 2014, the taxpayer was a resident of and worked in Massachusetts. However, at the time of recognizing the gain from the stock buyout in 2015, he was a resident of New Hampshire. 

Massachusetts personal income tax law includes a rather broad provision pertaining to the taxation of nonresidents on income derived from a trade of business. Notably, taxable Massachusetts source income for nonresidents includes income derived from or effectively connected with any trade or business, including any employment carried on by a taxpayer in Massachusetts, whether or not the nonresident is actively engaged in the trade or business in the year the income is received.² Thus, income can be sourced to Massachusetts based on an individual’s prior active engagement in a trade or business conducted in Massachusetts. 

Further, gross income derived from or effectively connected with a trade or business is defined to include gain from the sale of a business or of an interest in a business.³ Although the applicable regulations indicate that these rules generally do not apply to the sale of shares of stock in a C or S corporation, the regulations have been interpreted as intending to exclude from Massachusetts source income items of income that are passive in nature and unrelated to an individual’s employment by or active participation in the business entity. 

Unpacking the ruling

Given the breadth of Massachusetts rules in this regard and the taxpayer’s significant involvement in the corporation, the Appellate Tax Board held that the gain from the stock sale was attributable to his employment at the corporation and thus effectively connected with the trade or business of employment in Massachusetts. Thus, the taxpayer was subject to Massachusetts income on the gain from the sale of stock.

This case illustrates the importance of analyzing the level of a taxpayer’s active involvement in a business in which they own an interest. This active versus passive investment analysis is becoming increasingly important to determine whether gain resulting from the sale of an interest in a corporation or pass-through entity will be taxed only in a taxpayer’s state of residence or whether the taxpayer might be subject to tax in one or more states where the company has business activity. 

Thiscase follows a 2022 decision in Massachusetts where the passive nature of the owner’s investment resulted in certain gain not being treated as Massachusetts source. For more information on that case, please refer to Aprio’s July 12, 2022 article, Massachusetts Rejects State Attempt to Tax Out-of-State Entity’s Gain from Sale of Partnership. 

The bottom line

Addressing the multistate income tax consequences of the sale of an interest in a pass-through entity or corporation is a complicated analysis that needs to take into consideration a variety of factors based on the existing guidance in each applicable state. 

Aprio’s SALT team has experience with analyzing these issues, and we can assist you by recommending potential structuring alternatives to minimize multistate tax liabilities and by ensuring that you comply with your multistate income tax obligations so that you do not incur unexpected liabilities or penalties. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

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¹ Welch v. Commissioner of Revenue, Dkt. No. C339531, 11/29/2023.

² Mass. Gen. Laws c. 62 § 5A.

³ 830 CMR 62.5A.1(3)(c)8.