April 28, 2025

Executive Summary

Earlier this month, the Massachusetts (“MA”) Appeals Court upheld the decision of the MA Appellate Tax Board (the “Board”) in determining that a nonresident’s sale of stock was subject to MA personal income tax due to the taxpayer’s employment, active involvement, and management of the corporation at issue in Welch v. Commissioner of Revenue, No. 24-P-109 (MA App. Ct., Apr. 3, 2025). The Appeals Court and the Board both reached this conclusion even though the taxpayer did not receive the stock as compensation for services performed for the company. Therefore, business owners and founders residing outside of MA should be aware of the potential MA tax implications associated with the sale of their businesses stemming from the case.

Facts of the Case

The taxpayer was the founder, director, and chief officer of a software company headquartered in MA. The taxpayer was an original shareholder with 50% of the company stock. Through a series of financing transactions, the taxpayer’s ownership stake was diluted down to 11% of the company. During this time, the taxpayer continued to work for the company and reside in MA. The taxpayer eventually moved from MA and left his position with the company. Pursuant to the financing agreements, the taxpayer had to sell his stock to the company upon resignation.

As a nonresident of MA, the taxpayer did not include the capital gain from the sale of stock as income subject to MA tax. Upon audit, the MA Department of Revenue (the “Department”) included the gain from the stock sale in taxpayer’s MA source income and assessed MA income tax. The taxpayer challenged the Department’s assessment at the Board, which determined that the stock gain was of a compensatory nature resulting from his employment and was derived from and effectively connected with the trade or business carried on by the taxpayer. Therefore, the capital gain from the stock sale was determined to be sourced to and taxable in MA.

Court of Appeals Holding

The Appeals Court agreed with the Board and ruled in favor of the Department holding that the stock which the taxpayer sold was “derived from and effectively connected with his trade or business or employment.” According to the Appeals Court, because the taxpayer obtained the stock upon the founding of the company and expected that the value of the stock would appreciate because of his “hard work,” the Board had “substantial evidence” for determining that taxpayer’s gain was derived from MA sources.

The Court’s decision relies upon the statutory language describing MA source income as income “derived from or effectively connected with . . . any trade or business, including any employment carried on by the taxpayer in the commonwealth” and “gain from the sale of a business or of an interest in a business….” Mass. G.L. c. 62, §5A(a).

Case Commentary

While the Appeals Court relied upon the definition of MA source income found in the statute, there is a very specific regulation on point that was not carefully addressed. Specifically, the Department’s regulation for a nonresident’s personal income tax provides that sales of stock should generally not generate MA-source income for nonresidents unless such gains are treated as compensation for federal income tax purposes or the stock at issue is connected with the conduct of business in MA (including employment). See 830 CMR 62.5A.1.

While the taxpayer continued to actively manage and direct the company as an employee, his stock was received as an original founder. In fact, the taxpayer first organized the company and held all the original stock when the company was first founded. Despite this distinction between stock earned as employee compensation versus stock received as a founder/owner, the Appeals Court treated the sale of stock as if it was earned as compensation because of the taxpayer’s active involvement with the business up until his resignation from the company.

Based on this decision, nonresident shareholders of MA-based corporations may need to consider their activities and involvement with the corporation prior to determining MA income tax ramifications from a potential stock sale. Making matters worse is the prospect for double taxation if the taxpayer’s state of residence does not provide a resident credit for tax paid to MA in these situations due to not using the same sourcing analysis for such a sale of stock by a nonresident under similar circumstances.

Finally, the Court’s holding in Welch is difficult to reconcile with the MA Supreme Judicial Court’s holding in VAS Holdings & Investments LLC v. Commissioner of Revenue, 489 Mass. 669 (2022). In VAS Holdings, the MA Supreme Judicial Court determined that an S corporation’s sale of a partnership interest did not generate unitary income that could be subject to tax by MA, even though the selling S corporation had no independent or separate operations and activities aside from holding its interest in the partnership that was sold.

The seemingly contrary results of these cases suggest that the MA income tax ramifications from the sale of a pass-through entity (“PTE”) business can deviate based on the seller’s legal structure and level of involvement with the business. However, this planning paradigm may be coming to an end soon based on Governor Maura Healey’s recommended budget bill which clarifies that anytime there is a sale of a PTE interest, the business activities and apportionment factors of the entity being sold are attributable to the owners, regardless of owner type. The legislation would prevent any nonresident owner from selling an interest in a PTE business conducting activities in MA without recognizing MA-source gain.

Conclusion

Business owners and investors which have equity interests in companies currently operating in MA, in addition to those who are contemplating new business ventures for future commercial activity in MA, must seek proper guidance and tax planning advice to maximize profits upon a future sale. Due to the magnitude and complexity of these issues and recommended budget legislation, we recommend reviewing with your tax advisor for planning and compliance purposes. Please reach out to Jaime Reichardt or another member of Citrin Cooperman’s State and Local Tax leadership team if you have any questions on the contents of this article.