CRAIG H. WELCH & Another v. COMMISSIONER OF REVENUE

APPEALS COURT

CRAIG H. WELCH & another[1] vs. COMMISSIONER OF REVENUE

Docket:

24-P-109

Dates:

January 14, 2025 – April 3, 2025

Present:

Grant, Brennan, & Toone, JJ.

County:

Suffolk

Keywords:

Taxation, Income tax, Capital gain, Abatement. Corporation, Stock. Sale, Of stock. Statute, Construction. Administrative Law, Agency's interpretation of statute.

Appeal from a decision of the Appellate

Tax Board.

Michael J. Bowen (Eric P. Rothenberg also

present) for the taxpayers.

Celine E. de la Foscade-Condon for

Commissioner of Revenue.

GRANT, J.

In this case, we consider whether the Commissioner of Revenue

(commissioner) may treat as Massachusetts source income the gain realized by

Craig H. Welch (Welch) and his spouse, Natalia I. Welch (collectively, the

Welches), from the sale of stock in Welch's former employer, AcadiaSoft, Inc.

(AcadiaSoft).2 Welch acquired the stock

in 2005 soon after founding AcadiaSoft and continued to work for AcadiaSoft in

Massachusetts, where he also resided, for the next decade, but was no longer a

Massachusetts resident when he sold the stock in 2015. The Welches appeal from a decision of the

Appellate Tax Board (board) concluding that they were not entitled to an

abatement of Massachusetts income tax on Welch's gain from that sale.

The central issue before us is whether the

gain from that sale 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).

In the circumstances of this case, we conclude that Welch's gain from

the sale was "derived from or effectively connected with" his trade

or business or employment at AcadiaSoft, G. L. c. 62,

§ 5A (a), even though at the time of the sale he was no longer

"actively engaged in a trade or business or employment in the

commonwealth," id. Accordingly, we

hold that the gain was Massachusetts source income and affirm the board's

decision.

Background. The case was submitted to the board on a

statement of agreed facts with attached exhibits, including deposition

testimony of Welch and outside counsel for AcadiaSoft. We summarize the facts found by the board,

supplemented by other uncontested facts.

AcadiaSoft develops and markets derivative

and collateral management solutions for institutional investors. At all relevant times, AcadiaSoft was

headquartered in Massachusetts and filed Massachusetts corporate excise tax

returns apportioning one hundred percent of its income to Massachusetts.

In 2003, Welch formed AcadiaSoft as a

Massachusetts corporation. He was its

sole stockholder and held the titles of president, treasurer, clerk, and sole

director. That corporation was

voluntarily dissolved, and in 2005, another Massachusetts corporation by the

same name was organized. Welch was its chief

executive officer (CEO) and treasurer, and Danny J. Moyse, a software engineer,

was its chief technology officer, president, and secretary. Welch and Moyse were AcadiaSoft's sole

directors, and each held a fifty percent interest in its common stock.

Between 2003 and 2015, Welch worked

exclusively for AcadiaSoft. In AcadiaSoft's

early years, Welch's main focus was sales.

He described himself as AcadiaSoft's "chief evangelist": he "created the desire for the product

with the potential customers," "designed what the product needed to

do," "sold it," and "financed it." During 2003 through 2009, he worked about

eighty hours each week. However, he

reported no wage income for 2003 through 2005.

He reported only minimal income in 2006 ($5,533.77) and 2007

($7,235.42). Welch expected that in the

future AcadiaSoft would be worth a lot more than it was when he started it, and

he was looking forward to the payout from his hard work, "[w]henever that

came."

In 2006 and 2007, AcadiaSoft raised

funding from a group of "angel" investors -- individuals who did not

work for the company but who became the holders of 28.[2] percent of its common

stock. Welch promised he would do his

best to get them "a handsome return" on their investment. As a result of that recapitalization, Welch's

share of AcadiaSoft stock was diluted to 35.9 percent.

Until about 2009, Welch and Moyse were

running AcadiaSoft from their respective homes, both located in

Massachusetts. Welch primarily worked in

Massachusetts. About twice a month he

traveled to New York to solicit funding, but he returned home to Massachusetts

the same day.

In 2009, AcadiaSoft merged into a Delaware

corporation by the same name. AcadiaSoft

then entered into a transaction by which it obtained funding from financial

services firms, resulting in the dilution of Welch's share of AcadiaSoft stock

to approximately thirteen percent. In

addition, Welch became bound by an agreement that identified him as a

"[k]ey [h]older" of AcadiaSoft stock and provided him with a

financial incentive to remain employed by AcadiaSoft: if within the next eighteen months Welch left

AcadiaSoft's employment in certain circumstances, AcadiaSoft would have an

option to purchase his shares for one cent per share, adjusted for transactions

including stock splits. With funds from

that 2009 transaction, AcadiaSoft obtained office space in Pembroke. Welch went to the office about once a month

but continued to work mainly out of his home in Lynnfield.

Beginning in 2010, Welch was the CEO of

AcadiaSoft.[3] He focused on operations,

management, and sales. All AcadiaSoft

personnel reported to Welch, and he was involved in matters including hiring,

assessing legal claims, formulating business plans, and seeking equity

financing.

In about 2012, AcadiaSoft's office moved

to Norwell. Welch went to the Norwell

office usually once a week, but otherwise he worked from his home in

Lynnfield. Welch traveled frequently to

New York and London on business, but AcadiaSoft did not have an office in

either city.

In 2013, AcadiaSoft entered into another

round of financing with financial services firms. As a result, Welch's share of AcadiaSoft

stock was further diluted to 11.86 percent, where it remained until he left the

company in 2015.

Beginning in about 2014, Welch perceived

tension between himself and one or more of the other AcadiaSoft directors, and

he became concerned that his so-called "sweat equity" was in

jeopardy. By January 2015, Welch was CEO

in name only: he no longer had any operational

role in AcadiaSoft but retained the CEO title at the request of the board of directors

because he was "high profile" in the industry.

For the years 2003 through 2014, the

Welches filed Massachusetts resident income tax returns. The Welches moved to New Hampshire on or

about April 30, 2015, which was the last day of the Welches' Massachusetts

residency.[4]

In June 2015, AcadiaSoft offered to

purchase Welch's shares, contingent on all the holders of common stock agreeing

to sell their shares. Welch accepted the

offer and, on June 26, signed a letter resigning as an officer and director of

AcadiaSoft, but he made his resignation contingent on the sale of his shares so

that he could retain some leverage in the form of his founder's veto in the

event that the sale did not occur.

AcadiaSoft entered into another round of financing and then purchased

the entirety of Welch's shares.

AcadiaSoft issued Welch a 2015 1099-B tax

form reporting that, on June 29, 2015, Welch had received cash proceeds of

$4,744,759.96, with no cost or other basis, for the sale of his shares. For 2015, the Welches filed a Massachusetts

nonresident/part-year resident tax return, on which they reported that amount

as having been included as a capital gain on their Federal tax return. On their Massachusetts tax return, the Welches

did not include the $4,744,759.96 gain as income from a Massachusetts source.

After an audit, the commissioner notified

the Welches of an assessment totaling $335,968.62 in tax, interest, and

penalties based on the gain realized by the sale of the AcadiaSoft stock. The Welches applied for an abatement, which

was deemed denied after months of inaction.

The Welches appealed to the board from the denial of abatement. The board ruled that Welch's gain from the sale

of his AcadiaSoft shares was Massachusetts source income because it was effectively

connected with his trade, business, or employment in Massachusetts within the

meaning of G. L. c. 62, § 5A (a). The Welches appeal.

Discussion. 1.

Standard of review. "We

defer to the board's expertise with respect to the interpretation of tax laws

in the Commonwealth." U.S. Auto

Parts Network, Inc. v. Commissioner of Revenue, 491 Mass. 122 , 127-128 (2022),

quoting VAS Holdings & Invs. LLC v. Commissioner of Revenue, 489 Mass. 669 ,

674 (2022) (VAS Holdings). See Oracle

USA, Inc. v. Commissioner of Revenue, 487 Mass. 518 , 522 (2021) ("Because

the board is an agency charged with administering the tax law and has expertise

in tax matters, we give weight to its interpretation of tax statutes"

[citation and alteration omitted]).

"If the board's construction of a tax law 'is reasonable, we will

defer to its interpretation.'"

Reagan v. Commissioner of Revenue, 491 Mass. 446 , 451 (2023), quoting

Oracle USA, Inc., supra. At the same

time, "[w]e adhere to the familiar principle that tax statutes are to be

strictly construed; we will not read into a statute an authority to tax that it

does not plainly confer[,]" and "[a]ny ambiguity is resolved in the

taxpayer's favor" (citations omitted).

Commissioner of Revenue v. Oliver, 436 Mass. 467, 470-471 (2002). "We will not reverse a decision of the

board if it is based on substantial evidence and on a correct application of

the law" (quotation and citation omitted).

U.S. Auto Parts Network, Inc., supra at 128.

2.

Statutory interpretation. We

start with the plain language of the statute as in effect on June 29, 2015,

when Welch sold his AcadiaSoft shares.

The statute empowered the commissioner to tax nonresidents on their

Massachusetts source income, which it defined to include

"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).

G. L.

c. 62, § 5A (a). In 2003,

the Legislature amended § 5A (a) to add the words underlined

above. See St. 2003, c. 4, § 7

(2003 amendment).[5]

Before the 2003 amendment, Massachusetts

courts construed the prior version of the statute as not permitting taxation of

income derived from a nonresident's Massachusetts employment in a prior

year. See Oliver, 436 Mass. at 474

(prior version of § 5A did not permit taxation of nonresident on pension

benefits earned from past Massachusetts employment); Destito v. Commissioner of

Revenue, 23 Mass. App. Ct. 977, 978 (1987) (reading prior version of § 5A

to imply that for income earned by nonresident to be taxable, it must be

received within same tax year as nonresident worked in Massachusetts). "As amended, the statute now permits a

tax on a nonresident who did business in the Commonwealth regardless of whether

the business was conducted in that particular year." VAS Holdings, 489 Mass. at 688 n.23.

Before the 2003 amendment, § 5A also

did not define the phrase "derived from or effectively connected with any

trade or business." By the 2003

amendment, the Legislature added the following language:

"For

purposes of this section, gross income derived from or effectively connected

with any trade or business, including any employment, carried on by the

taxpayer in the commonwealth shall mean the 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. It shall include, but not

be limited to, gain from the sale of a business or of an interest in a business

. . . ."

G. L.

c. 62, § 5A (a), as amended by St. 2003, c. 4, § 7.

In construing that language added by the

2003 amendment, the board noted that § 5A (a) "incorporates an

exceedingly broad definition" of the phrase "derived from or

effectively connected with any trade or business." That definition includes the list of phrases

"results from, is earned by, is credited to, accumulated for or otherwise

attributable to," and specifically enumerates sources of taxable income as

including what occurred here: "gain

from the sale of . . . an interest in a business." G. L. c. 62, § 5A (a).

The board's interpretation of

§ 5A (a) is further informed by the regulation. As in effect on June 29, 2015, the regulation

stated,

"Income from

a trade or business may include income that results from the sale of

. . . an interest in a business.

This 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. . . . Such

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) . . . ."[6] (Emphases added.)

830 Code Mass.

Regs. § 62.5A.1(3)(c)(8).

Focusing on the word "not"

underlined above, the Welches argue that the regulation means that the

commissioner may not treat as Massachusetts source income Welch's gain from the

sale of his shares in AcadiaSoft, a C corporation.[7] As the commissioner points out, however, in

that sentence, the word "not" is qualified by the word

"generally." See Bartenwerfer

v. Buckley, 598 U.S. 69, 78 (2023) ("[a]s the word 'generally' indicates,

[the] rule is not absolute"). Read

as a whole, the regulation makes clear that the gain from the sale of stock in

a C corporation may constitute Massachusetts source income if "the stock

is related to the taxpayer's compensation for services." 830 Code Mass. Regs. § 62.5A.1(3)(c)(8).

We conclude that the board's

interpretation of § 5A (a) is reasonable. See VAS Holdings, 489 Mass. at 674. Against that statutory and regulatory

framework, this case turns on whether Welch's gain from his AcadiaSoft shares

was "derived from or effectively connected with" his trade or

business or employment, G. L. c. 62, § 5A (a), or "related to

[his] compensation for services," 830 Code Mass. Regs.

§ 62.5A.1(3)(c)(8).

3.

Application to this case.

Applying § 5A (a) to "the unique circumstances" of

this case, the board concluded that Welch's gain from the sale of his AcadiaSoft

shares was "compensatory" and "a remuneration that derived from

and was effectively connected with his AcadiaSoft employment."

At oral argument, the Welches contended

that the board's determination that Welch's gain was "compensatory"

is a conclusion of law that we should review de novo. The commissioner countered that it is a

finding of fact to which we should defer.

We view it as a mixed question of fact and law, and accord "some

deference" to the board's decision.

Boston Professional Hockey Ass'n v. Commissioner of Revenue, 443 Mass.

276, 285 (2005), quoting Koch v. Commissioner of Revenue, 416 Mass. 540, 555

(1993) ("In reviewing mixed questions of fact and law, the board's

expertise in tax matters must be recognized, and its decisions are due 'some

deference'").

The board concluded that Welch "was

not a passive investor in AcadiaSoft, but a founder whose continued employment

with the company ‑‑ in prominent, powerful, and crucial roles -- contributed to

its value." He "exclusively

devoted his life for more than a decade" to AcadiaSoft, "to which he

made crucial contributions that added to, and were critical to, the company's

value." The board emphasized

several events that linked Welch's ownership of AcadiaSoft stock to his

compensation. He acquired that stock

soon after he founded AcadiaSoft, dedicated himself to the success of

AcadiaSoft, and expected a payout for his sweat equity. In connection with the 2009 refinancing, he

became bound by an agreement that tied his status as a key holder of AcadiaSoft

stock to his continued employment with the company. Finally, Welch made his resignation from

AcadiaSoft contingent on the sale of his shares.

The Welches argue that Welch's gain from

the sale of his AcadiaSoft shares was not "derived from or effectively

connected with" his trade or business or employment within the meaning of

§ 5A (a). They advance two

arguments, neither of which persuades us that the board erred.

First, focusing on the terms "trade

or business" in § 5A (a), the Welches argue that it was

AcadiaSoft that conducted the trade or business of developing and marketing

derivative and collateral management solutions, not Welch personally.[8] This argument is unavailing because, as the

Welches acknowledge, the gain is taxable if it derived from Welch's trade or

business of working for AcadiaSoft. On

that point, the Welches argue that the stock was not compensation for Welch's

employment because AcadiaSoft had not yet conducted any business when Welch

acquired the stock in 2005, there is no evidence of an explicit agreement that

the shares were issued as compensation, and he was later paid a salary. While it is true that in many circumstances

when an employee of a corporation receives stock, the employer formally

designates it as compensation, see, e.g., Jones v. Jones, 101 Mass. App. Ct.

673 , 682 n.13 (2022), the absence of such a formal designation is not

determinative of the issue before us.

Here, because Welch obtained the stock soon after founding AcadiaSoft,

expected that in the future AcadiaSoft would be worth a lot more than it was

when he started it, and was looking forward to the payout from his hard work,

the board had substantial evidence on which to base its determination that

Welch's gain from the sale of the AcadiaSoft stock was derived from his

employment.

Second, the Welches contend that Welch

held his AcadiaSoft shares as an investment.

They point to the regulation's example (3)(c)(8.4), which posits that,

where an employee of a Massachusetts corporation lives out of State and

"purchases stock" in his employer's corporation "as an ordinary

investment unrelated in any way to his compensation," gain from the sale

of that stock would not be treated as Massachusetts source income. That example is not on point here because

Welch did not "purchase" his AcadiaSoft shares, and, as discussed

above, his acquiring the stock was related to his compensation.

We conclude that the board had substantial

evidence on which it based its determination that Welch's gain from the sale of

his AcadiaSoft shares was derived from his own trade or business of software

development. See Commissioner of

Internal Revenue v. Groetzinger, 480 U.S. 23, 35 (1987) (full-time gambler was

engaged in "trade or business" within meaning of 26 U.S.C.

§§ 162 [a] and 62[1]; "to be engaged in a trade or business, the

taxpayer must be involved in the activity with continuity and regularity and

. . . the taxpayer's primary purpose for engaging in the activity

must be for income or profit").

Conclusion. The board determined that Welch's gain from

the sale of his shares of AcadiaSoft stock was "derived from and was

effectively connected with" his trade or business or employment, and

therefore it was taxable as Massachusetts source income. We conclude that the board's decision was

based on substantial evidence and a correct application of the law.

Decision of the

Appellate Tax Board affirmed.

footnotes

[1] Natalia I.

Welch.

[2] During

Welch's employment, AcadiaSoft took three different corporate forms, each of

which was called by the same name. We

use that name to refer to each of them.

[3] Moyse had

served as CEO for several months beginning in December 2009.

[4] The

commissioner does not argue that when Welch sold his AcadiaSoft shares on June

29, 2015, his domicile was Massachusetts, and so we do not consider that issue.

[5] The

Legislature has made additional amendments to the statute since then, but none

of those amendments have altered the quoted language.

[6] The

regulation also provides that "gain from . . . the disposition

of shares of corporate stock will be considered Massachusetts source income if

it is treated as compensation for federal income tax purposes." 830 Code Mass. Regs.

§ 62.5A.1(3)(c)(8). The parties do

not argue that that part of the regulation applies, and so we do not consider

the issue.

[7] After its

2009 merger into the Delaware corporation, AcadiaSoft was taxed as a C corporation. See Bernier v. Bernier, 449 Mass. 774 , 775

n.2 (2007).

[8] The Welches

rely on Oliver, in which the court, construing the pre-2003 amendment version

of § 5A, concluded that a retiree living out of State and receiving a

pension from his former employer in Massachusetts did not "personally

conduct the Massachusetts business giving rise to the income." Oliver, 436 Mass. at 472 , quoting

Commissioner of Revenue v. Dupee, 423 Mass. 617, 620 (1996). Oliver is inapposite. At the time, § 5A permitted taxation of

a nonresident who conducted business in the Commonwealth during the taxable

year at issue. The version of

§ 5A (a) at issue here permits taxation of a nonresident who conducts

business in the Commonwealth "regardless of whether the business was

conducted in that particular year," VAS Holdings, 489 Mass. at 688 n.23.