Argument Recap:  Jefferson Allen, et al. v. Commissioner of Revenue Services, SC 19567

The Supreme Court heard oral argument in the case of Jefferson Allen, et al. v. Commissioner of Revenue Services, SC 19567, on October 13, 2016.  The issues in the case concern the constitutionality of Connecticut’s taxation of the exercise of qualified stock options by former residents when the options had no readily ascertainable value when received as part of compensation for work performed in Connecticut.  As part of this question, the Court is asked to interpret certain tax regulations referencing the applicable time period for taxing income derived from or connected with sources within this state.  Finally, because the nonresidents actually filed and paid income taxes within Connecticut for income from the exercise of qualified stock options in 2002, but later tried to amend and get a refund of those taxes, the Court is asked to address the issue of whether the statute of limitations is jurisdictional and equitably tolled by the existence of an audit.

Justices Zarella, Eveleigh, and McDonald, asked several questions directed to the distinctions between value earned and value realized, as well as the connection between the realized value and the State of Connecticut.  Justice McDonald presented a hypothetical question regarding tax treatment of a lawsuit seeking damages for discrimination after an employee moves out of state and whether this would present an analogous situation.  The justices, especially Justice Zarella, focused several questions on whether Connecticut would seek to tax this income if Nevada, the state where the Allens lived at the time that they exercised the options, had taxed this income.  The issue of “double taxation” and state tax credits dominated the questions directed to counsel for the State as to the constitutionality of Connecticut’s taxation of the income.

As to the arguments involving statutory construction of the relevant regulation (12-711(b)-189a)), the argument and questions presented focused on the meaning of “during” and whether the potential dual meanings require construction of a resulting ambiguity against the State and in favor of the taxpayer.  The language of the regulation makes income from the exercise of a nonqualified stock option taxable “if during the period beginning with the first day of the taxable year of the optionee during which such option was granted and ending with the last day of the taxable year of the optionee during which such option was exercised . . . the optionee was performing services within Connecticut.”  The taxpayer argues that “during” requires that he be performing services throughout that timeframe, as opposed to at any point of time within the timeframe, to be subject to taxation in Connecticut.  Both sides of the argument posited that a section providing for apportionment supports their interpretation of the regulation.  During rebuttal, the taxpayer’s counsel pointed out that New York’s statute avoids the ambiguity by using the language “at any time” and that Connecticut could have used such language if it intended such a meaning.

The justices did not ask any questions related to the statute of limitations issue, nor had Allen’s counsel addressed this issue during oral argument.  I’d anticipate the statute of limitations issue will be decided in favor over of the State.

Whether the Supreme Court comes down on the side of the taxpayer or not, it would not be surprising if the regulations are amended to eliminate this claimed ambiguity so that Connecticut’s intention and right to tax the exercise of nonqualified stock options earned as compensation in connection with employment in Connecticut is clear, no matter where the optionee resides at the time of exercising such options.