A new Massachusetts court ruling means you could owe state taxes on startup stock gains, even if you moved away years before selling. 

Quick Takeaways

• Massachusetts now claims the right to tax equity compensation tied to in-state work, even if the individual has moved out of state before selling.
• A recent court decision expands the definition of Massachusetts-source income to include startup stock tied to prior in-state employment.
• This could affect founders, early employees, and anyone with stock in a Massachusetts business.
• Exit planning and careful review of equity compensation agreements are now essential.
• Other states may follow this model to boost tax revenue.

Why Is Massachusetts Taxing Nonresidents on Startup Stock Gains?

A recent Massachusetts Appellate Court decision points to a clear shift in how states are viewing equity compensation, specifically targeting taxpayers who are nonresidents holding equity for a business operating in state. Traditionally, nonresidents in this situation selling equity would be required to source the gain to the state of residency. The Welch decision in Massachusetts looks to whether the income has ‘substantial ties to the jurisdiction’ which can have a much broader interpretation. 

Who Is Craig Welch and Why Does His Case Matter?

Craig Welch was a resident of Massachusetts when he co-founded AcadiaSoft, Inc. – a c-corporation based in Massachusetts. Welch subsequently moved to New Hampshire, and sold his share of AcadiaSoft, generating a large capital gain. Welch sourced this capital gain to New Hampshire; which was his state of residency at the time the sale took place. 

The state of Massachusetts disagreed and sought to impose Massachusetts income tax on the capital gain associated with the sale of AcadiaSoft. The Massachusetts Appellate Court agrees that Welch was issued stock as part of co-founding the company, and worked for the company for several years to grow/develop it. The Massachusetts Appellate Court also stated that at the time of the sale of AcadiaSoft, Welch was a resident of the state of New Hampshire. 

How Is Massachusetts Defining “Source Income” in This Ruling?

In seeking to tax the capital gain, Massachusetts argued that the taxing statute in Massachusetts requires that the income in question be “derived from or effectively connected with” his trade of business or employment at AcadiaSoft. The state is seeking to define this term very broadly, to include income that results from, is earned by, is credited to, accumulated for or otherwise attributable to the efforts of the individual awarded the equity compensation. 

The Appellate Court stated that the current regulations read as a whole make clear that the gain from the stock in a C corporation may constitute Massachusetts source income if “the state is related to the taxpayer’s compensation for services.” The court concluded that the shares provided were compensatory in nature and a “remuneration that derived from and was effectively connected with his AcadiaSoft employment.”

What Does This Mean for Founders and Early Employees?

The implications of this ruling to Massachusetts business owners are clear-- your equity compensation is subject to Massachusetts tax. This is despite the services associated with the compensation occurring well before the sale of stock, and the location of the individual providing the services who receives this equity compensation at the time of the sale. 

The state created a connection point between individuals’ equity compensation; the individual working in the state, and the business increase in value being associated with that individual’s in-state work; allows for the state of Massachusetts to tax the income generated on the sale. 

What Should You Do If You Have Equity in a Massachusetts Business? 

Welch is likely to appeal this decision to the Massachusetts Supreme Judicial Court so this is not the final say in how the state can seek to tax equity compensation. If allowed to stand, the implications of this ruling are vast:

1. Nexus which follows the income, not the individual. This is a clear path for the state to tax nonresidents on gains from stock/equity awards that are ‘inextricably linked’ to in-state work.
2. Equity agreements could come under new scrutiny. You should review all current equity compensation agreements involving Massachusetts. Ensure there is clear language surrounding the timing and nature of any equity grants.
3. The lines between deferred compensation and equity income are incredibly blurred. Essentially any founder of a business in Massachusetts can be seen as having Massachusetts sourced income, regardless of where that person lives.
4. Exit planning is now more essential than ever for those seeking to understand tax consequence of a sale/exit event. 

Could Other States Do the Same?

Absolutely. This ruling may open the door for other states to assert taxing rights over equity compensation linked to in-state business activity, regardless of where the taxpayer lives when they cash out. If upheld by the Supreme Judicial Court, this could mark a new era of aggressive state taxation tied to mobility and remote work.

FAQs- What Founders and Equity Holders Need to Know Now

1. If I moved out of Massachusetts years ago, can the state still tax my stock sale?

Yes, under the Welch decision, Massachusetts may claim taxing rights if your equity compensation is tied to work you performed while living in the state. Even if you moved long before the sale, the gain may still be considered Massachusetts-source income.

2. Does this only apply to company founders, or could employees be affected too?

This ruling has broader implications beyond founders. Early employees, executives, and anyone granted equity as part of their compensation package for work performed in Massachusetts may also be affected.

3. What can I do now to protect myself?

Start by reviewing your equity compensation agreements, especially if you’ve worked for a Massachusetts company. Consider working with a tax advisor to evaluate your exit strategy, sourcing rules, and potential exposure if you plan to sell stock in the future.