Founders and executives with equity compensation need to be prepared for state tax exposure, even in states where they do not live. In a landmark decision that reverberates beyond Massachusetts, the Massachusetts Appeals Court recently sided with the Department of Revenue in Welch v. Commissioner of Revenue, setting a new precedent on how nonresident business owners may be taxed on stock sales. The ruling signals a critical shift in how states may seek to tax income derived from activities that have substantial ties to their jurisdictions—even when the income arises long after the taxpayer has left the state.
Welch v. Commissioner of Revenue at a Glance
Craig Welch, a nonresident of Massachusetts, challenged the state’s attempt to tax him on capital gains he realized from selling stock in AcadiaSoft, Inc.—a company he co-founded and led as a key executive while residing and working in Massachusetts. Welch argued that the income was from intangible assets and therefore not taxable by Massachusetts since he was no longer a resident at the time of the sale.
However, the Massachusetts Appellate Tax Board disagreed. That Board found that the gains were not purely investment returns but were intrinsically tied to the work Welch performed while living and working in Massachusetts. The Board viewed the stock as a form of deferred compensation or reward for services performed within the state—making it subject to Massachusetts income tax despite Welch’s nonresident status at the time of sale. The Appeals Court affirmed that, even though ArcadiaSoft, Inc. was a Delaware corporation and Welch was a New Hampshire resident at the time of sale, the sale proceeds Welch received were derived from or effectively connected with a trade or business in Massachusetts.
Implications for Business Owners
This decision has wide-reaching implications for business owners, particularly those who have moved out of Massachusetts (or other states with similar tax regimes) but retain equity interests in companies they helped build.
- Employment-Based Nexus Expands Tax Exposure
The ruling establishes a clearer path for Massachusetts to tax nonresidents on gains from stock or equity awards that are “inextricably linked” to in-state work. Founders and executives should be aware that their past efforts in a state may establish a tax nexus that follows the income—not the individual.
- Deferred Compensation vs. Investment Income
The case underscores the state’s ability to reclassify what might otherwise be seen as investment income. If the equity was granted, earned, or substantially increased in value due to the taxpayer’s services in Massachusetts, the state may assert tax jurisdiction. In this case, the founder equity was treated as compensation even though the founder received a salary.
- Exit Planning Just Got More Complicated
Entrepreneurs contemplating relocation or a liquidity event should factor in the possibility of post-exit state tax exposure. Proper tax planning and legal structuring at the time of company formation, equity issuance, and exit can help mitigate unexpected tax liabilities.
- Precedent for Other States
While this decision is rooted in Massachusetts law, it could inspire other states to adopt similar positions—particularly those facing budget shortfalls or seeking to expand their tax base. Nonresident founders and executives should take note, especially in high-tax jurisdictions like California and New York.
What Should You Do?
- Review Equity Compensation Agreements: Ensure there is clarity around the nature and timing of any equity grants or vesting tied to in-state work.
- Document Your Tax Position: If you’ve relocated, maintain detailed records of where services were performed and when value was earned.
- Plan Ahead for Liquidity Events: Work with legal and tax counsel early—before you sell your company or exercise options.
- Consider Residency Audits: Be prepared for scrutiny if you are a former resident realizing substantial gains. States are increasingly aggressive in auditing high-net-worth individuals post-exit.
Final Thoughts
The Welch decision represents a turning point for how states approach the taxation of mobile entrepreneurs and executives. It serves as a powerful reminder that, in the eyes of state tax authorities, where you earned the value matters more than where you realize it.
Business owners should take this ruling seriously and consult with experienced tax professionals to avoid surprises—and to protect the rewards of their hard work.
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