The Liquidation Exception to Business Income: When It Does and Doesn’t Apply

February 26, 2021

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Some states provide an exemption to business income for liquidations and will instead classify gains from such transactions as nonbusiness income. However, the specific requirements for claiming the liquidation exemption must be satisfied, and states are likely to apply a narrow interpretation to those requirements.

By: Betsy Tuck, State and Local Tax Manager at Aprio

In the state income tax arena, one of the issues that is audited most often is the treatment of gains from the sale of business assets or subsidiaries as either apportionable business income or allocable nonbusiness income. A recent New Jersey case addresses an issue that may arise in some states: the liquidation exception to business income.

Case in point: Elan Pharmaceuticals

The taxpayer, Elan Pharmaceuticals, Inc. (Elan), is a pharmaceutical company focusing on neurology, autoimmune diseases and severe pain management. As the result of an acquisition in 2000, Elan entered the oncology drug business, producing ABELCET® and Myocet®.

In 2002, Elan sold its U.S., Canadian and Japanese ABELCET business for $360 million. The proceeds of the sale were ultimately distributed to Elan’s direct parent company, Athena Neurosciences, which then distributed the proceeds to its own parent company, Elan PLC, to reduce corporate debt; other parts of the proceeds were distributed to other Elan group companies.

On its New Jersey corporate income tax return, Elan treated the gain from the sale (approximately $340 million) as nonoperational income and allocated the income outside of New Jersey. The state disagreed with the approach and instead treated the gain as operational income that is apportionable to the state based on Elan’s New Jersey apportionment percentage.

New Jersey uses the term “operational income” (similar to what other states call “business income”) and defines it as “income from tangible and intangible property if the acquisition, management or disposition of the property constitutes an integral part of the taxpayer’s regular trade or business operations.” Income is only nonoperational income if “a taxpayer demonstrates with clear and convincing evidence” that it is not operational income.[1]

Why the liquidation exception doesn’t apply to Elan’s case

Some states, through either administrative or judicial guidance, have established what is commonly referred to as a “liquidation exception to business income.” New Jersey applies a liquidation exception which states that gains from sales may be nonoperational income if “the sale constitutes a complete or partial liquidation of a business, and the sale proceeds have not been reinvested into the business.”[2]

In this case, the court determined that the sale did not meet the liquidation exception. To start, there was not a complete or partial liquidation of the business; after the transaction, Elan still had the rights to ABELCET in other markets, and it still owned the rights to Myocet as well. Thus, the sale did not constitute a liquidation of Elan’s oncology drug business but was instead limited to the sale of its rights to ABELCET in three markets.

Second, the proceeds from the sale were not invested back into the business — remember, they were used to reduce corporate debt and reimburse reinvestment expenditures, and they were paid to other Elan group companies.

The bottom line

When selling a business, taxpayers should be aware of the liquidation exception and its requirements when evaluating gains as business or nonbusiness income.

Aprio’s State & Local Tax (SALT) team has experience with business/nonbusiness income issues and state liquidation exceptions, and we can help businesses structure their transactions to minimize state income tax liabilities. Plus, we constantly monitor these and other important state tax topics, so that you’re continually up-to-speed on the rulings that matter most to your business.

Keep an eye out for other significant developments on this case in future issues of the Aprio SALT Newsletter.

Contact Betsy Tuck, SALT Manager at or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the February 2021 SALT Newsletter.

[1] N.J. Rev. Stat. § 54:10A-6.1

[2] McKesson Water Prods. Co. v. Dir., Div. of Taxation, 23 N.J. Tax 449, 457 (Tax 2007), aff’d, 408 N.J. Super. 213 (App. Div. 2009).  Without such an exception, it is understood that such income otherwise meets a state’s definition of business/operational income.

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About the Author

Jeff Glickman

Jeff Glickman is the partner-in-charge of Aprio, LLP’s State and Local Tax (SALT) practice. He has over 18 years of SALT consulting experience, advising domestic and international companies in all industries on minimizing their multistate liabilities and risks. He puts cash back into his clients’ businesses by identifying their eligibility for and assisting them in claiming various tax credits, including jobs/investment, retraining, and film/entertainment tax credits. Jeff also maintains a multistate administrative tax dispute and negotiations practice, including obtaining private letter rulings, preparing and negotiating voluntary disclosure agreements, pursuing refund claims, and assisting clients during audits.