The Ohio Supreme Court’s decision in Corrigan v. Testa.1has led the Ohio Department of Taxation (“Department”) to issue refunds to nonresident taxpayers who have previously paid tax on the capital gain from the sale of a business interest that is conducted within the state.
Under R.C. 5747.212, amended in 2002, tax is imposed on a capital gain realized by an out-of-state investor in a pass-through entity if that investor held a 20% or greater interest in the entity during a three-year period. The statute imposed the tax on the gain based on the apportioned percentage of the entities business conducted in the state.
In the case, Mr. Corrigan, a resident of Connecticut, owned 79% of an LLC that produced sanitary ware, with plants in Texas and California, but conducted business in all 50 states. Corrigan’s role in the company’s management was as “an investor who bought companies with the intention of providing financing and strategic expertise to grow the company for an eventual exit via a sale to a third party”.2 Corrigan stressed in his argument to the Department that he did not participate in the active management of the business’s day-to-day operations. In 2004, Corrigan sold his interest in the business realizing a capital gain that was sourced outside of Ohio, specifically since he was not a resident within the state. Ohio then assessed Mr. Corrigan for the gain that should have been apportioned to Ohio under R.C. 5747.212.
The Court noted the difference in treatment for business and non-business income for nonresidents in its opinion. Business income is the income from the regular course of a trade or business and apportioned by the percentage of the business’s property, payroll, and receipts located in Ohio.3 Ohio nonbusiness income includes capital gains from the sale of intangible personal property, which is sourced to the domicile of the taxpayer. 4
The Court concluded that while Mr. Corrigan availed himself of Ohio’s protection and benefits with respect to the LLC’s income during his ownership, the opposite was true for the gain that resulted from the sale of his intangible interest in the business. The Court held that Corrigan’s intangible ownership interest did not avail him of Ohio’s protections and benefits in any direct way and therefore R.C. 5747.212, as applied to Mr. Corrigan, violated the Due Process Clause of the Fourteenth Amendment of the Constitution. It’s important to note, that the court held that R.C. 5747.212 was unconstitutional as it applied to Mr. Corrigan and not on its face. The Court noted, conceivably, that a taxpayer may engage in conduct with or through a business entity where the imposition of the statute would not be unconstitutional – mainly if the taxpayer establishes a unitary relationship with the business.
What does this mean for taxpayers?
Mainly, nonresident taxpayers who sourced the gain on the sale of their partnership interest in a business that was being conducted in Ohio should analyze their factual situations in order to determine if there is a potential refund opportunity under the state’s four year statute of limitation. Strong consideration should be given to the level of involvement that taxpayer had in the business’s Ohio operations and whether the taxpayer would be considered “unitary” with the business. Additionally, the Corrigan decision raises planning opportunities around the sale of an interest in a business, whether that being the type of sale (asset v. intangible) or taxpayer residency considerations.
Have questions on how the Corrigan decision may affect your Ohio state taxes? Reach out to the State and Local Tax team at Schneider Downs.
Corrigan v. Testa, 149 Ohio St.3d 18, 2016-Ohio-2805, 2016.
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