Learn about the complex tax implications when selling a business across states. Explore a case involving Idaho’s pursuit of $1.4 million in taxes from a Virginia pass-through equity gain.
M&A Stories
February 9, 2021
Selling a Business Across States: Tax Implications:
When selling a successful business, the profits earned can be subject to both federal and state income taxes. This becomes more complex when the business operates in multiple states, as different states might claim the right to tax the same profits.
The Case in Question:
In this instance, a former U.S. Navy SEAL established a Virginia S corporation, starting from his garage, producing gear for military, law enforcement, and recreational purposes. After about a decade, he transferred most of his company’s assets to a newly created Virginia LLC in exchange for a 79% ownership stake. This LLC was a pass-through entity, meaning it didn’t opt to be taxed as a C corporation.
The Virginia LLC expanded its operations to Idaho, purchasing property, hiring employees, and setting up a factory. In 2010, the founder’s S corporation sold its majority stake in the Virginia LLC for $120 million. The S corporation reported the gain on its Idaho tax return but claimed it as nonbusiness income allocated solely to Virginia, thereby avoiding Idaho taxes on the gain.
The Legal Battle:
Idaho’s tax authority demanded a $1.4 million tax payment, arguing that a portion of the gain should be taxed in Idaho as business income. The S corporation countered that the gain was nonbusiness income allocated to Virginia, thus not subject to Idaho tax. The dispute reached the courts. Ultimately, the Idaho Supreme Court sided with the taxpayer, stating that the S corporation was essentially a passive holding company. As such, the gain from selling the LLC stake was considered nonbusiness income and not subject to Idaho taxation as business income. However, two out of five Idaho Supreme Court justices dissented from this decision.
This case is referred to as Noell Industries, Inc. v. Idaho State Tax Commission, Docket No. 46941, Supreme Court of Idaho, Boise, January 2020 Term, (Opinion filed: May 22, 2020). The U.S. Supreme Court declined the state’s request to review the decision.
Comment
The legal landscape in this area is still evolving, and selling a stake in a business that operates across multiple states can lead to potential double taxation. Fortunately, there’s a process for resolving such disputes through mediation and arbitration under the Multistate Tax Compact. This procedure involves the involvement of the selling entity, the states of Virginia and Idaho, and aims to provide a resolution to these complex tax situations.
Fortunately, there’s a process for resolving such disputes through mediation and arbitration under the Multistate Tax Compact. This procedure in this case would have seller, and the states of Virginia and Idaho. This procedure aims to provide a resolution to these complex tax situations.
For more details, you can refer to this article: INSIGHT: Persistence Pays Off in Sale of Idaho Pass-Through Entity https://www.bradley.com/-/media/files/insights/publications/2020/07/sup-materialsarticle-persistence-pays-off-in-sale-of-idaho-passthrough-entity-bely-july-2020.pdf
By John McCauley: I help people manage M&A legal risks.
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