The Massachusetts Appeals Court’s decision in Craig H. Welch & another vs. Commissioner of Revenue, No. 24-P-109 (Mass. App. Ct. April 3, 2025), provides crucial guidance for CPAs navigating the complexities of Massachusetts income tax for nonresidents, particularly concerning the taxation of capital gains from the sale of stock. This article will delve into the facts of the case, the taxpayers’ claim for an abatement, the court’s detailed analysis of the relevant statute and regulations, the application of these legal principles to the specific circumstances, and the ultimate conclusions reached by the court.

Facts of the Case:

Craig H. Welch (Welch) founded AcadiaSoft, Inc. (AcadiaSoft) in Massachusetts in 2003. Initially, he was the sole stockholder, holding various titles including president, treasurer, clerk, and sole director. In 2005, another Massachusetts corporation under the same name was formed, with Welch as CEO and treasurer, and he held a fifty percent interest in its common stock. Throughout his tenure from 2003 to 2015, Welch worked exclusively for AcadiaSoft in Massachusetts, focusing on sales in the early years and later transitioning to operations, management, and sales as CEO beginning in 2010. AcadiaSoft was headquartered in Massachusetts and consistently apportioned 100% of its income to the state for corporate excise tax purposes.

Over the years, AcadiaSoft underwent several funding rounds and a merger into a Delaware corporation in 2009. These transactions diluted Welch’s stock ownership, eventually reaching 11.86 percent by 2013, where it remained until his departure. Notably, in connection with the 2009 financing, Welch entered into an agreement identifying him as a key holder of AcadiaSoft stock, which included a financial disincentive for leaving the company within eighteen months. For the years 2003 through 2014, Welch and his spouse, Natalia I. Welch (collectively, the Welches), filed Massachusetts resident income tax returns.

On or about April 30, 2015, the Welches moved to New Hampshire, marking the end of their Massachusetts residency. In June 2015, AcadiaSoft offered to purchase Welch’s shares, contingent on all common stockholders agreeing to sell. Welch accepted and resigned his officer and director positions on June 26, 2015, making his resignation contingent on the sale of his shares. The sale was completed on June 29, 2015, with Welch receiving cash proceeds of $4,744,759.96 and a reported basis of zero. For the 2015 tax year, the Welches filed a Massachusetts nonresident/part-year resident tax return, excluding the gain from the sale of AcadiaSoft stock as Massachusetts source income.

Taxpayers’ Request for Relief:

Following an audit, the Commissioner of Revenue (commissioner) issued an assessment totaling $335,968.62 in tax, interest, and penalties based on the gain from the sale of the AcadiaSoft stock. The Welches applied for an abatement, arguing that the gain was not Massachusetts source income. After their application was deemed denied due to inaction, they appealed to the Appellate Tax Board (board).

Court’s Analysis of the Law:

The central issue before the Appeals Court was whether the gain from the sale of stock was Massachusetts source income subject to tax under G. L. c. 62, § 5A and 830 Code Mass. Regs. § 62.5A.1(3)(c)(8) (2006) (regulation). The court began its analysis by examining the plain language of G. L. c. 62, § 5A (a), as in effect on June 29, 2015, which empowers the commissioner to tax nonresidents on their Massachusetts source income, defined as:

"items of gross income derived from or effectively connected with . . . 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" (emphasis added by the court referencing the 2003 amendment).

The court highlighted the 2003 amendment to § 5A (a), which added the emphasized language, explicitly overruling prior interpretations that did not permit taxation of income derived from a nonresident’s Massachusetts employment in a prior year, citing Commissioner of Revenue v. Oliver, 436 Mass. 467, 474 (2002) and Destito v. Commissioner of Revenue, 23 Mass. App. Ct. 977, 978 (1987). The amended statute now permits taxation regardless of whether the business was conducted in the particular year the income is received, citing VAS Holdings & Invs. LLC v. Commissioner of Revenue, 489 Mass. 669, 688 n.23 (2022).

Furthermore, the 2003 amendment also broadened the definition of "gross income derived from or effectively connected with any trade or business" to include 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". This definition specifically includes "gain from the sale of a business or of an interest in a business". The board had interpreted this definition as "exceedingly broad".

The court then considered the relevant regulation, 830 Code Mass. Regs. § 62.5A.1(3)(c)(8), which states that "[i]ncome from a trade or business may include income that results from the sale of . . . an interest in a business". However, it also contains an exception: "[t]his 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 . . .". This exception is qualified by a further provision: "[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) . . ." (emphasis added by the court).

The Welches argued that the "generally does not apply" language meant the commissioner could not treat Welch’s gain from the sale of his C corporation stock (AcadiaSoft) as Massachusetts source income. However, the court agreed with the commissioner that the word "generally" qualifies the exception, indicating it is not absolute, citing Bartenwerfer v. Buckley, 598 U.S. 69, 78 (2023). The court concluded that the regulation clearly allows for the gain from the sale of C corporation stock to be considered Massachusetts source income if the stock is related to the taxpayer’s compensation for services.

Ultimately, the court found the board’s interpretation of § 5A (a) to be reasonable, citing VAS Holdings, 489 Mass. at 674. The crucial question then became whether Welch’s gain was "derived from or effectively connected with" his trade or business or employment, pursuant to G. L. c. 62, § 5A (a), or "related to [his] compensation for services", under 830 Code Mass. Regs. § 62.5A.1(3)(c)(8).

Application of Law to Facts:

The board concluded that Welch’s gain was "compensatory" and "a remuneration that derived from and was effectively connected with his AcadiaSoft employment". The Appeals Court considered this determination a mixed question of fact and law, according "some deference" to the board’s expertise in tax matters, citing Boston Professional Hockey Ass’n v. Commissioner of Revenue, 443 Mass. 276, 285 (2005) and Koch v. Commissioner of Revenue, 416 Mass. 540, 555 (1993).

The board emphasized that Welch was not a passive investor but a founder whose continued employment in crucial roles significantly contributed to AcadiaSoft’s value. The court highlighted the following factors supporting the board’s conclusion:

Welch acquired the stock shortly after founding AcadiaSoft.
He dedicated over a decade to the company, making critical contributions to its value.
He expected a payout for his "sweat equity".
The 2009 refinancing agreement tied his key holder status to continued employment.
Welch made his resignation contingent on the sale of his shares.

The Welches argued that the gain was not derived from Welch’s trade or business or employment, contending that AcadiaSoft, not Welch, conducted the business of developing and marketing software. They also argued that the stock was not compensation because there was no explicit agreement, AcadiaSoft had not yet conducted business when he acquired the stock in 2005, and he later received a salary. The court dismissed the argument that Welch did not personally conduct a business giving rise to the income, distinguishing the case from Oliver, 436 Mass. at 472, because the amended version of § 5A (a) allows taxation regardless of when the business was conducted, citing VAS Holdings, 489 Mass. at 688 n.23. The court also stated that the lack of a formal designation of the stock as compensation was not determinative, particularly given the circumstances of Welch’s founding and early contributions.

The Welches further argued that Welch held the shares as an investment, pointing to a regulatory example (830 Code Mass. Regs. § 62.5A.1(3)(c)(8.4)) where an out-of-state employee purchasing stock in their employer as an ordinary investment unrelated to compensation would not have Massachusetts source income from its sale. The court found this example inapplicable because Welch did not "purchase" his shares, and their acquisition was related to his compensation.

The court concluded that the board had substantial evidence to determine that Welch’s gain was derived from his own trade or business of software development, citing Commissioner of Internal Revenue v. Groetzinger, 480 U.S. 23, 35 (1987) for the definition of "trade or business."

Court’s Conclusions:

The Appeals Court affirmed the Appellate Tax Board’s decision, holding that Welch’s gain from the sale of his AcadiaSoft stock was "derived from and was effectively connected with" his trade or business or employment in Massachusetts and was therefore taxable as Massachusetts source income. The court found that the board’s decision was based on substantial evidence and a correct application of the law.

Implications for CPAs:

This case underscores the importance of considering the underlying relationship between stock ownership and employment or business activities when determining Massachusetts source income for nonresidents. The "generally does not apply" exception in the regulation regarding capital gains from stock sales is not absolute. CPAs advising nonresidents who have received stock, particularly in closely held companies or as founders, should carefully analyze the facts and circumstances to determine if the stock was related to the taxpayer’s compensation for services rendered in Massachusetts. Factors such as the timing of stock acquisition relative to employment, the taxpayer’s role in building the company’s value, and any agreements linking stock ownership to employment are crucial in this analysis. This decision reinforces the broad reach of Massachusetts’ sourcing rules for income derived from activities within the Commonwealth, even when the income is realized after the taxpayer has become a nonresident.

Prepared with assistance from NotebookLM.

The text of the case can be read at the link below:

Craig H. Welch & another vs. Commissioner of Revenue, No. 24-P-109 (Mass. App. Ct. April 3, 2025)