Thinking of moving out of state in connection with the sale of your business which you spent a lifetime building to avoid Massachusetts income taxes? You better think again or at least the Commonwealth of Massachusetts is forcing you to think again!

In a recent Appellate Tax Board Decision, named Welch v. Commissioner Docket No. C339531, a Massachusetts taxpayer changed his residence to New Hampshire on April 30, 2015. Subsequently, on June 29, 2015 the taxpayer sold his 11.86% ownership interest in a business he began and grew, back to the company for $4,744,759. The Commonwealth did not dispute the timing of the change in domicile nor did the Commonwealth dispute the fact that the sale took place after the taxpayer had changed his residence. The Commonwealth, however, decided to ignore its own long-standing regulations relative to a nonresident's sale of stock in a C corporation or an S corporation and implement what appears to be a new subjective rule.

This issue seemed to be well settled by virtue of the fact that on August 8, 2008 CMR 62.5A.1(3)(c)(8) was issued, which basically provides that a nonresident is not subject to capital gain taxes attributable to a sale of their stock in a C or S corporation to the extent that it is reported as a capital gain transaction on the federal income tax return. This is exactly what happened in the Welch case. The Commonwealth, however, decided to stretch this rule by pointing out that the Regulation said "generally" and relied on the statute that provides that, to the extent a sale is attributable to a business effectively carried on in the Commonwealth of Massachusetts, any gain would be subject to the Massachusetts income tax. The board found, that due to the Mr. Welch’s extensive involvement in the corporation and his self-proclaimed importance, the sale on the stock was really back-end compensation in exchange for services rendered rather than a sale of a true investment.

It should be noted that this case was decided before the new Massachusetts Millionaire's Tax, which imposes a 4% tax on Massachusetts income in excess of $1,000,000 regardless if whether it is capital gain or ordinary income for federal income tax purposes. In this case, the taxpayer had reported no basis in the stock so that the entire $4,744,759 was subject to taxes. The Massachusetts income tax was $244,132 but the assessment included $48,836 in interest and $42,950.62 in penalties, for a total of $335,968.62.

Had this sale taken place on or after January 1, 2024, an additional 4% on the gain over $1,000,000 would have generated an additional income tax of $149,790.36. The new Millionaire's Tax has generally been thought of as the last straw for many individuals, and in particular anyone thinking of selling their business. So far in 2024, the tax has generated $2,200,000,000 in additional revenue for the Commonwealth of Massachusetts.

If you are planning to sell your business in connection with either living in a state other than Massachusetts such as New Hampshire or Florida, there are lessons to be learned from the Welch case. First, during depositions, the taxpayer continued to emphasize that he was the “chief evangelist” and “chief cook and bottle washer” and that he worked 24/7 to build the company up. Furthermore, he stated “I was the product and the product was me” and that he was happy with a lower salary for many years because “he was looking forward to the payout from his hard work ‘Whenever that came, at some point in time.’” (A lesson in how not to help yourself in a deposition!)

The taxpayer unfortunately made it clear that it was his business and he alone was responsible for its success despite the fact that the company had undergone several rounds of private equity investments. Initially, the taxpayer had a 50% ownership interest which was diluted to 35% after the first round, 22% after the second round, and approximately 11.86% after the third round of institutional financing. The taxpayer reported no basis attributable to the shares allowing the Commonwealth to presume that the shares were issued for services rendered rather than in exchange for a capital contribution.

It should be noted that the company had relocated its operations to Delaware and became a "C corporation" but nevertheless apparently conducted all of its business in Massachusetts, or at least from an income tax point of review. While it had sales in numerous other states, the company continued to report all of its income to Massachusetts and did not allocate any income to any other states in which it purportedly did business. While this certainly simplified reporting for the corporation, it came back to haunt Mr. Welch as the Board cited this reporting practice as one of the deciding factors.

Procedural History:

The Appellate Tax Board is the first step of an appeal process following an assessment that the taxpayer would like to appeal. This case has been now appealed to the "Appeals Court" for a decision that hopefully respects precedent, regulations and Massachusetts Law.

We will keep you posted. If you have any questions or need additional information, please contact our Corporate Law & Tax group, Attorney Leo J. Cushing, Attorney Jenna R. Wolinetz, or Robert J. DuCharme.

Thank you.

Leo J. Cushing, Esq. – lcushing@cushingdolan.com

Jenna R. Wolinetz, Esq. – jwolinetz@cushingdolan.com

Robert J. DuCharme – rducharme@cushingdolan.com