Refund Potential for Ohio Non-Residents
Ohio’s taxation of a non-resident’s capital gain from LLC sale deemed invalid
In a recent decision by the Ohio Supreme Court, the capital gain resulting from the sale of a non-resident’s ownership interest in an LLC, in which he did not participate in day-to-day management of operations, was not subject to tax in Ohio. In Corrigan v. Testa, the Ohio Supreme court confirmed that the gain was non business income, not subject to Ohio taxation.
Ohio imposes income tax on individuals residing in or receiving income from Ohio. A 2002 Amendment to Ohio’s tax laws provided that a capital gain realized by a non-resident investor, who held an interest of 20% or more in a pass-through entity, would be subject to tax in Ohio. Further, the amendment provided that the capital gain would be apportioned to Ohio based on the apportionment percentages for property, payroll and sales located in Ohio used over the last three-years, including the year of sale.
In 2000, Corrigan purchased a 79% interest in Mansfield Plumbing LLC (Mansfield), a pass-through entity doing business in Ohio. Corrigan held the title of manager, but he really assumed the role of steward rather than an active manager of the business. For example, although Corrigan would visit Mansfield’s headquarters for board meetings and management presentations involving operations, labor, finance and strategic positions; he was not involved in the day-to-day operations of Mansfield.
In 2004, Corrigan sold his interest in Mansfield and realized a $27 million gain. On his personal return, Corrigan treated the entire capital gain as Ohio non-business income. As such, the entire gain was allocated outside of Ohio pursuant to Ohio’s rules for the allocation of non-business income.
Subsequently, in 2009, the Ohio Department of Taxation issued Corrigan an assessment for unpaid tax relating to the $27 million capital gain realized on the 2004 sale of the Mansfield interest. Corrigan paid a portion of the assessment and then filed a refund claim on the basis that Ohio’s tax law violated both the Due Process and Dormant Commerce Clauses of the US Constitution. The Department of Taxation denied his refund claim, which was then also denied by the Board of Tax Appeals. Corrigan then appealed the Board’s decision to the Ohio Supreme Court.
The Due process clause of the US Constitution requires a minimum connection between the state and the person or activity it desires to tax.  The issue before the Court was whether Ohio may constitutionally levy an income tax on the capital gain realized as a result of the sale of a more than 20% interest owned by a nonresident of Ohio in a pass-through entity (an intangible asset) doing business in Ohio. The Court concluded that there was no direct connection between Mr. Corrigan and the state of Ohio for this ownership interest, and reversed the decision by the Board of Tax Appeals to deny Mr. Corrigan’s refund claim.
Nonetheless, the Ohio Supreme Court would not go so far as to say that this portion of Ohio Law is unconstitutional in all cases, as there is a possibility that the statute could be applied when a unitary-business situation is present.
For Your Consideration
After the Corrigan decision, there may be refund opportunities available for similar fact based situations, where income tax was paid by an out of state resident on the sale of an interest in a pass through entity doing business in Ohio. Ohio’s statute of limitations for filing refund claims is four years from the due date of the original tax return filing.
There is also a possibility that the State of Ohio may petition the US Supreme Court to review the Ohio Supreme Court’s decision in Corrigan.
Please contact us for a more in depth discussion of this case and your situation.
 Ohio Rev. Code § 5747.02(A)
 Ohio Rev. Code § 5747.212(B)
 Ohio Rev. Code § 5747.20
 Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805, paragraph 30
 Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805, paragraph 69