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Minnesota Clarifies Treatment of Sale of Goodwill but Uncertainty Lingers

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Minnesota Clarifies Treatment of Sale of Goodwill but Uncertainty Lingers

A recent decision from the Supreme Court of Minnesota (“Court”), Cities Mgmt., Inc. v. Comm’r of Revenue, No. A23-0222, 2023 Minn. LEXIS 597 at 1 (Minn. Nov. 22, 2023) (“CMI”), clarifies the distinction between business and nonbusiness income in Minnesota’s tax law as applied to the sale of goodwill in a closely held business. The case gives taxpayers a view of how such provisions may be analyzed and interpreted in other states. As in many states, there is still a lot of uncertainty in how the provisions should be applied to sales of closely held business that contain other fact patterns. Although the Commissioner of Revenue prevailed in this case, he received a thorough scolding from the Court due to taking a position inapposite of prior case law, which also underscores the need for clarity in these situations.


While Minnesota law makes use of the business/non-business income duality, it does not have a typical statutory scheme with a definition of “business income” derived from the MTC’s original UDITPA model. Instead, the pertinent section, Minn. Stat. § 290.17, contains various subdivisions, the most pertinent of which are:

Subdivision.2 Income not derived from conduct of a trade or business, which contains numerous paragraphs covering allocation rules for non-business income. Paragraph (c) includes the treatment of “gain on the sale of goodwill . . . that is connected with a business operating all or partially in Minnesota[.]”

Subdivision.3 Trade or business income; general rule, which provides that “[a]ll income of a trade or business is subject to apportionment except nonbusiness income.”

Subdivision.4 Unitary business principle, which, among other things, provides that, for businesses operating at least partially within Minnesota, “the entire income of the unitary business is subject to apportionment . . . . Notwithstanding subdivision 2, paragraph (c), none of the income of a unitary business is considered to be derived from any particular source and none may be allocated to a particular place except as provided by the applicable apportionment formula.”

Subdivision.6 Nonbusiness income, which provides that “Nonbusiness income is income of the trade or business that cannot be apportioned by this state because of the United States Constitution or the constitution of the state of Minnesota . . . . Nonbusiness income must be allocated under subdivision 2.”

The basic facts in CMI are not unusual. CMI was a Minnesota S corporation that did business in Minnesota and Wisconsin. A related S corporation, Under Construction Services, Inc., had the same ownership, was unitary with CMI, and was sold as part of the same transaction.[1] The individual taxpayer in the case was a nonresident individual who, along with her co-owner, sold her stock to an unrelated third party, making an I.R.C. 338(h)(10) election at the request of the purchaser. As stipulated at the Minnesota Tax Court, the taxpayer was the founder of the business, but was not involved in the day-to-day management or operations of the business.” Cities Mgmt., Inc. v. Minn. Comm’r of Revenue, Minn. Tax Court, Dec. 20, 2022, fn.8.

The taxpayer treated the gain from sale as falling under Subd. 2, paragraph (c). This non-business income provision, the only paragraph in § 290.17 specifically dealing with “gain on the sale of goodwill,” provides that such gain be “allocated to this state to the extent that the income from the business in the year preceding the year of sale was allocable to Minnesota under subdivision 3.” The taxpayer followed prior case law, as explained below.

Non-Acquiesce in Prior Case Not Made Public

To fully understand the taxpayer’s position, it is important to know that years earlier, the Minnesota Tax Court, an administrative tribunal, had issued a decision interpreting § 290.17 in another business sale case involving an IRC 338(h)(10) election, Nadler v. Comm’r of Revenue, No. 7736 R, (Minn. T.C. Apr. 21, 2006). In Nadler, the Tax Court had held that subdivision 2(c) was the applicable provision in such a case, and that this paragraph’s language regarding the allocation method meant that the recognized gain sitused to Minnesota was capped by the amount of income the business had apportioned to Minnesota in the previous year. In CMI, use of that method resulted in the taxpayer reporting a much smaller amount than if the entire gain were apportioned.

Unbeknownst to the taxpayer (in CMI) or their CPA at the time of making the I.R.C. 338(h)(10) election or filing their return, the Commissioner of Revenue, although he didn’t appeal the Tax Court’s decision, had not acquiesced to the Nadler holding. Nor did the Commissioner announce to the public his non-acquiescence, at least not until the release of Revenue Notice 17-02, two years after the CMI sale and more than ten years after the Nadler decision. CMI’s non-resident owner was assessed, with the Commissioner asserting that the gain was apportionable business income under subdivision 3.

Ambiguous Statute Clarified by Legislative History

In determining which was the correct provision to apply to the CMI gain, the Court acknowledged “that section § 290.17 is not a model of statutory clarity,” and [b]oth parties’ interpretations are supported by the statutory language.” The Court determined “that the treatment of gain on the sale of goodwill under section § 290.17 is ambiguous” and the Court had to turn to the legislative history of the statute to determine the Legislature’s intent. The Court’s analysis of contemporaneous evidence such as audio tape of the hearings leading to the 1999 revision of § 290.17 led to the conclusion that the Legislature’s intent was “to overrule Firstar’s functional test and put in place a purely constitutional distinction between business and nonbusiness income.”

In Firstar Corp. v. Commr. of Revenue, 575N.W.2d 835 (Minn.1998) and its companion case, Hercules Inc. v. Comm’r of Revenue, 575 N.W.2d 111 (Minn. 1998), the Court had adopted a combination of functional and transactional tests to determine whether income was business or nonbusiness. But the legislature felt these tests were too restrictive and resulted in less tax paid by out-of-state taxpayers and more by in-state taxpayers. The revisions to § 290.17 that came out of the legislative reaction to these cases included the new definition of “nonbusiness income” in subdivision 6 with reference to constitutional limits, and the new first sentence in subdivision 3: “All income of a trade or business is subject to apportionment except nonbusiness income.” CMI at 25.

The Holding and the Scolding

Once the Court had determined the legislature’s intent was to expand the notion of apportionable business income, it held that the Commissioner’s interpretation of § 290.17 was “more reasonable” than CMI’s, and the Commissioner won the case. CMI at 25. The gain was determined to be business income and thus apportioned based on the company’s apportionment factor in the year of sale.

However, as noted above, the Court had harsh words for the Commissioner’s long-term failure to make public its non-acquiescence to a Tax Court decision it had not appealed, writing, “We fear that such actions do little to inspire the trust and confidence of taxpayers in Minnesota’s tax system.” The dissent would have gone much further, creating an equitable rule that would bind the Commissioner to non-appealed Tax Court decisions “unless the Department of Revenue provides public notice of its disagreement[.]” CMI at 28 (Anderson, J., dissenting). This rule would have resulted in a decision for the taxpayer in CMI and any other case where the taxpayer had relied on the prior decision in Nadler.

ZHF Observation

The taxpayer in CMI was comfortable making the I.R.C. 338(h)(10) deemed asset sale election thinking that Nadler would protect her. If she had not made such an election, would the sale have been apportionable? Under the election, the sale is treated as if the business sold its assets, realizing the gain at the business level before it flows through to the individual investor. The subdivision 4 rule requires such business income to be apportioned if the business is unitary. But if the sale had taken place without the election, the gain would appear only at the taxpayer level. Would the answer depend on whether the taxpayer’s own activities were unitary with the business sold? The CMI taxpayer had founded the business but was not, at the time of sale at least, involved in its management. Further, the concept of “unitary” was developed via case law involving sales by corporations, and most of the cases have followed that fact pattern. In a previous Buzz, we reported on a 2022 Massachusetts decision holding that the U.S. Constitution does not require unity, but that Massachusetts law does. But when an individual sells their interest in a closely held business, must the individual be unitary with the business for the gain to be apportionable?

The Ohio Supreme Court, in Corrigan v. Testa, 2016-Ohio-2805, held a statute making income apportionable for certain non-residents to be unconstitutional as applied to Corrigan (the taxpayer), “in light of the absence of any assertion or finding that Corrigan’s own activities amounted to a unitary business with that of Mansfield Plumbing” (the business sold). Corrigan at ¶ 68. Ohio’s recently clarified definition of “business income” at Revised Code 5747.01(B) includes sales treated as asset sales for federal income tax purposes, as well as those where the taxpayer’s material participation in the business can be demonstrated. For other equity sales, the Ohio Department of Taxation might view the gain as non-business income not subject to apportionment.

If you would like to further discuss the contents of this post, please reach out to any of our professionals.

[1] To keep the discussion simple, Under Construction Services, Inc. is not discussed herein. The sale included both and, because they made up a unitary business, the issues were resolved as one. The statutory definition of “unitary business’ in Minnesota states that the term may be applied . . . between multiple entities.” § 290.17 Subd.4.(b).

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