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TAX NEWS - January 2010

Income/Franchise Tax - Alabama:
Nonresident S corporation shareholder is subject to tax on distributive share of IRC ยง338(h)(10) asset sale gain

James E. Prince, Jr. v. Department, Ala. Ct. App. (1/22/10). The Alabama Court of Civil Appeals affirmed that a nonresident shareholder of an in-state "S" corporation owed Alabama individual income tax on his distributive share of the "S" corporation's deemed asset sale gain, because:

- A valid Internal Revenue Code (IRC) Sec. 338(h)(10) election had been made by the shareholders,

- Alabama has adopted, for state income tax purposes, the federal income tax treatment of a company that makes an IRC Sec. 338(h)(10) election, and

- Despite the 2006 Lanzi case (which held that Alabama lacked statutory authority to tax the income of a Georgia limited partner of a partnership doing business in Alabama), the nonresident here had sufficient nexus with Alabama because the transaction involved the sale of all the "S" corporation's assets, rather than merely the individual's one-third ownership interest.

The shareholder unsuccessfully argued that:

- The income he received from the merger transaction could not be taxed under Alabama law because the merger only involved the sale of his shares of stock in the "S" corporation, which he owned in Mississippi, and the sale of which occurred in Georgia, and

- Alabama's taxation of his income from the merger transaction violated both Due Process and Commerce Clauses, because he did not transact any business in Alabama.

The Court explained that the fact that the nonresident owned his "S" corporation shares in Mississippi was of no consequence, as the income he received was not based on the sale of his stock but, rather, on the distributive share of income that he received from the deemed sale of assets that were located in Alabama. This deemed asset sale, the Court reasoned, was pursuant to an IRC Sec. 338(h)(10) election, which he and the other shareholders chose to make.
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