In a decision with troubling potential implications, a Massachusetts appellate court held that a nonresident individual was subject to Commonwealth income tax on capital gain from the sale of his stock in the corporation that he formed and worked for because the court concluded that it related to his trade or business in the Commonwealth. Craig H. Welch v. Comm’r of Rev., No. 24-P-109 (Mass. App. Ct., Apr. 3, 2025).
The Facts: In 2003, Craig Welch (“Welch”), a resident of Massachusetts at the time, formed AcadiaSoft, Inc. (“AcadiaSoft”), a Massachusetts-based business that developed and marketed derivative and collateral management solutions to institutional investors. Over more than a decade, Welch worked exclusively for AcadiaSoft in various capacities, including as its President, Chief Executive Officer, and Treasurer, primarily in Massachusetts, and received a salary. Although initially the corporation’s sole stockholder, over time his stock ownership percentage was diluted as outside investors were brought in and additional financing was obtained.
By 2015, however, Welch no longer had an operational role at AcadiaSoft. In June 2015, AcadiaSoft offered to purchase Welch’s stock, and he accepted the offer and submitted his resignation. Later that month, AcadiaSoft purchased Welch’s stock for $4.7 million. Since Welch had a zero cost basis in his stock, the entire sales proceeds were capital gains for federal income tax purposes.
Significantly, on or about April 30, 2015—two months before the sale—Welch and his wife had moved to New Hampshire, and he was no longer a Massachusetts resident.
From 2003 through 2014, Welch and his wife had filed Massachusetts resident income tax returns. No longer a resident after April 30, 2015, Welch filed a Massachusetts nonresident/part year resident tax return for 2015 but did not report the $4.7 million capital gain as Massachusetts source income.
After an audit, the Department of Revenue (“Department”) assessed income tax on the capital gain, treating it as Massachusetts source income. The Massachusetts Appellate Tax Board (“ATB”) upheld the imposition of the tax, ruling that the stock gain “was of a compensatory nature” attributable to Welch’s employment in Massachusetts. This appeal followed.
Taxation of Massachusetts Non-Residents: Like most states, Massachusetts taxes nonresident individuals only on their in-state source income. “Massachusetts source income” is defined to include 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).
The Department‘s regulations provide that the taxation of gain from the sale of a business applies to the sale of interests in, for example, sole proprietorships and partnerships, but that this rule “generally does not apply… to the sale of shares of stock in a C corporation or S corporation, to the extent that the income from such gain is characterized for federal income tax purposes as capital gains,” unless it is “connected with the taxpayer’s conduct of a trade or business . . ..” 830 Code Mass. Regs. § 62.5A.1(3)(c)(8).
Welch argued on appeal that it was AcadiaSoft that was conducting a trade or business, not Welch personally, and that his stock was not compensation for his services since he acquired it before AcadiaSoft conducted any business.
The Decision: The Court, applying a deferential standard of review, upheld the taxation of Welch’s capital gain from the stock sale, holding that it was “derived from and was effectively connected with his trade or business or employment.” According to the Court, because Welch obtained the stock soon after founding AcadiaSoft and expected that the value of the stock would appreciate because of his “hard work,” the ATB had substantial evidence for concluding that Welch’s gain “was derived from his employment.”
Observations: The Court’s decision fails to recognize the distinction between AcadiaSoft’s business—for which it filed Massachusetts corporate tax returns and apportioned 100 percent of its income to the Commonwealth—and Welch’s employment with AcadiaSoft for which he received a salary and paid Commonwealth income tax. Also troubling is that the Court failed to apply the Department’s own regulation providing that Massachusetts source income generally does not include gain from the sale of stock in a corporation characterized as capital gains, not compensation for services, for federal tax purposes. The Court emphasized Welch’s desire that his stock appreciate in value because of his efforts, but that can be said about every founder of a business who anticipates that the business will be successful and that the value of the stock will increase over time. If left standing, the decision would make Massachusetts an outlier in taxing founders of corporate businesses who eventually wish to sell their stock and exit the business.