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jurisdictiontrialtax lawcorporation
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Prince v. State Dept. of Revenue, 55 So.3d 273

Facts

In 1996, two Alabama residents formed Zebra.Net, Inc., an S corporation, and later invited Mississippi resident James E. Prince to invest, making him a one-third shareholder. In 1999, the shareholders entered into a merger agreement, which allowed them to elect to treat the merger as a sale of the corporation's assets under federal tax law. Following the merger, the Alabama Department of Revenue assessed income tax against Prince for his share of the income from the sale of Zebra.Net's assets, which he contested, arguing that Alabama lacked jurisdiction to tax him as a nonresident.

In 1996, two Alabama residents formed a corporation called Zebra.Net, Inc. (“Zebra.net”), an Alabama corporation. The Alabama residents elected to have Zebra.net treated as an “S corporation” for federal income-tax purposes.

Issue

Did the Alabama Department of Revenue have the authority to impose an income tax on a nonresident shareholder's distributive share of income from an S corporation's asset sale?

Did the Alabama Department of Revenue have the authority to impose an income tax on a nonresident shareholder's distributive share of income from an S corporation's asset sale?

Rule

The court applied the principle that a state may tax nonresident shareholders of an S corporation on income derived from business conducted within the state, provided there is a sufficient connection between the state and the income.

The court applied the principle that a state may tax nonresident shareholders of an S corporation on income derived from business conducted within the state, provided there is a sufficient connection between the state and the income.

Analysis

The court found that the shareholders, including Prince, had made a valid election under 26 U.S.C. § 338 to treat the merger as a sale of Zebra.Net's assets, which generated income that passed through to Prince. The court concluded that the income was attributable to the S corporation's operations in Alabama, thus establishing the necessary nexus for Alabama to impose the tax on Prince's distributive share.

The court found that the shareholders, including Prince, had made a valid election under 26 U.S.C. § 338 to treat the merger as a sale of Zebra.Net's assets, which generated income that passed through to Prince.

Conclusion

The court affirmed the trial court's judgment in favor of the Alabama Department of Revenue, upholding the tax assessment against Prince.

The court affirmed the trial court's judgment in favor of the Alabama Department of Revenue, upholding the tax assessment against Prince.

Who won?

The Alabama Department of Revenue prevailed because the court found that the tax assessment was valid under Alabama law and did not violate federal constitutional provisions.

The Alabama Department of Revenue prevailed because the court found that the tax assessment was valid under Alabama law and did not violate federal constitutional provisions.

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