The Case of Craig Welch: A Cautionary Tale

Craig Welch, the former CEO of AcadiaSoft, learned this lesson the hard way. After founding the Massachusetts-based company in 2005 adn serving as its CEO for a decade, Welch moved too New Hampshire in April 2015. Just a couple of months later, in June, he resigned and sold his AcadiaSoft shares for a cool $4.7 million. Welch and his wife didn’t include that sum on their Massachusetts tax return.

The Massachusetts Department of Revenue (DOR) took notice, issuing an assessment of $335,968. The Appellate Tax Board sided with the DOR, arguing that the gain from the stock sale was tied to Welch’s business and employment in massachusetts. Now, the Appeals Court has affirmed that decision.

Judge Marguerite T. Grant wrote for the panel, stating that gain from the sale of stock in a C corporation like AcadiaSoft may constitute Massachusetts source income if “the stock is related to the taxpayer’s compensation for services.”

The Legal Nuances: A Deep Dive

At the heart of the matter is G.L.c. 62,§5A(a),the Massachusetts statute governing taxation of income earned by nonresidents. The key question is whether Welch’s stock sale was “effectively connected” to his trade,business,or employment within the Commonwealth.

The Appeals Court leaned heavily on the regulation clarifying this statute,wich states that stock sales can be considered Massachusetts source income if the “stock is related to the taxpayer’s compensation for services.” The court found that Welch’s situation met this criteria.

According to Judge grant, “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.”
Welch, et al. v. Commissioner of Revenue, Lawyers Weekly No.11-021-25.

“A Bombshell” and a “New Direction”

The decision has sparked considerable debate within the tax community. Boston tax attorney richard L. Jones calls it a “bombshell.”

We thought it was settled law that nonresidents selling corporate stock that wasn’t acquired as compensation wouldn’t be subject to tax when they sold that stock. It’s unclear how broadly this could be applied, but it’s certainly a new direction Massachusetts is taking — and a direction most states wouldn’t take.

— richard L. Jones,Boston

This ruling potentially broadens the scope of what Massachusetts considers taxable income for former residents. it raises concerns about how aggressively the state will pursue similar cases in the future.

Laura A. Brown, a tax attorney in Rockland, argues that this is the DOR “getting greedy” and that it shows how the regulations are being expanded to capture people who live out of state.

The potential Exodus?

Brown fears the ruling could incentivize businesses and individuals to leave Massachusetts. “This is just going to drive businesses from Massachusetts to New Hampshire and Florida, and pretty soon [Boston Mayor Michelle] Wu’s housing crisis will be resolved because everyone’s going to sell their houses and work somewhere else,” she said.

While this may be hyperbole, it highlights the potential economic impact of aggressive tax policies. States like New Hampshire and Florida, with no state income tax, become increasingly attractive destinations for businesses and high-net-worth individuals.

The Cost of Fighting Back

Even if the Welches ultimately prevail, the cost of fighting the assessment could be substantial.

brown offers a stark warning: “If I’m counseling a client in a situation like this about whether or not to put something down as income in Massachusetts, I might say to them, ‘OK, you’re getting $4.7 million. Do you want to pay a couple hundred grand as an insurance policy? Or would you rather spend so much more in penalties and interest,plus probably six figures in attorney fees and eight years of your life fighting this?’”

This illustrates the arduous choices taxpayers face when dealing with complex and potentially aggressive tax interpretations.

“Crawl Under the Table and Cry”

Leo J. Cushing of Waltham highlights the specific facts that may have doomed Welch’s case. Welch’s own testimony during the Appellate Tax Board proceeding painted a picture of someone deeply involved in building AcadiaSoft from the ground up.

Cushing recounted Welch’s testimony: he was AcadiaSoft’s “chief evangelist” and “chief cook and bottle washer”; that he worked “24-7” to build up the company; and that he had been happy with a lower salary for many years because he looked forward to the payout from his hard work, whenever that might be.

“This is the kind of testimony that makes you want to crawl under the table and cry,” Cushing said. “He set himself up for the commissioner to say,‘Yes,you’re selling stock,but in reality,you’re getting paid for a business that you ran in Massachusetts,and this is a form of compensation.’”

This highlights the importance of careful planning and clear documentation when structuring compensation packages, especially for founders and early employees.

AcadiaSoft: from Startup to Acquisition Target

Welch founded AcadiaSoft in 2003, initially holding all the key positions. Over the years, the company evolved, attracting investors and undergoing mergers. Welch’s ownership stake was diluted through various funding rounds.

By 2014, Welch’s role had diminished, although he retained the title of CEO.The following year, he moved to New Hampshire and subsequently sold his shares back to the company.

The Court’s Reasoning: It’s All About Compensation

The Appeals court agreed with the Appellate Tax Board’s assessment that welch’s gain was essentially compensatory.

Grant emphasized several factors: Welch acquired the stock early in acadiasoft’s history, dedicated himself to the company’s success, and expected a return on his “sweat equity.” Furthermore, a 2009 agreement tied his stock ownership to his continued employment.

The court rejected the Welches’ argument that the sale should be treated as an ordinary investment, unrelated to compensation. Welch didn’t “purchase” his shares in the traditional sense; his acquisition was directly linked to his role in founding and building the company.

According to grant, “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.”

FAQ: Frequently Asked Questions

• Can I avoid Massachusetts tax by moving before selling stock? Not necessarily.It depends on the circumstances of your stock ownership and your connection to the company while you were a Massachusetts resident.
• What if I purchased the stock as a regular investment? The ruling focuses on situations where the stock is linked to compensation for services rendered.
• Does this ruling affect everyone who leaves massachusetts? No, it primarily affects those who received stock options or ownership as part of their compensation while working in Massachusetts.
• What should I do if I’m in a similar situation? Consult with a qualified tax attorney or accountant specializing in Massachusetts residency and source income rules.