The Supreme Court has issued it decision in the case of Jefferson Allen, et al. v. Commissioner of Revenue Services, SC 19567. The case decided the issue of 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. However, when exercised during a period of time when the taxpayers were nonresidents of Connecticut, the combined options at issue resulted in over 50 million dollars of income. As part of this question, the Court was 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 was asked to address the issue of whether the statute of limitations is jurisdictional and equitably tolled by the existence of an audit.
The Court’s decision, written by Justice Eveleigh, decided all of the issues in favor of the defendant, the Commissioner of Revenue Services.
As to the proper interpretation and application of the tax regulation governing taxation of stock options, the Court held that the regulation is unambiguous. The regulation at issue provides in relevant part: “Connecticut adjusted gross income derived from or connected with sources within this state includes income . . . in connection with a nonqualified stock option 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 . . . . “ Regs, Conn. State Agencies §12-711(b)-18(a). As applied to the circumstances of this case, the regulation requires only that the taxpayer have been performing services in Connecticut at the time the options were granted. The Court applied the well-established rules of statutory construction to conclude that the meaning of “during” within the regulation is “at some point in the course of . . . .” and does not require, as the Plaintiffs argued, that the taxpayer be a resident throughout the entire timeframe referenced in the regulation. The meaning of “during” proposed by the Plaintiffs would create disharmony within the regulation and lead to bizarre results, both of which are to be avoided. Alternatively, the Commissioner’s interpretation is a reasonable construction which “comports comfortably with the due process principle that a state may tax the compensation of nonresidents who perform services within the taxing state.” The Court held that because Mr. Allen was performing services solely within Connecticut when he earned the stock options in 2005, the income derived from the exercise of those option in 2006 and 2007 is properly taxable under § 12-711(a)-18(a) of the regulations.
The Court also concluded that Connecticut’s imposition of taxes on the nonresident’s exercise of stock options did not violate the due process clause of the federal constitution. Due process requires satisfaction of a two part test: “(1) there exist some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax, as well as (2) a rational relationship between the tax and the values connected with the taxing state.” The Court agreed with the Commissioner that “the fact that Allen was granted the stock option as compensation for performing services in Connecticut serves as a sufficient nexus to the state to satisfy the requirements of the due process clause.” The Court rejected the arguments that the jurisdictional nexus was severed when the Allens moved out of the state and that the income was not as a result of performing services in Connecticut, but the result of appreciation in the value of the underlying stock. The “rational relationship” prong, which has typically been applied to determine apportionment of income for multistate business enterprises, was deemed inapplicable to the constitutional analysis, because it was undisputed that Allen was awarded the stock options for performing services only in Connecticut.
As to the statute of limitations, the Court held that the statutory scheme setting forth the time frame within which a taxpayer may claim a tax refund and the appeal process creates a limited waiver of the state’s sovereign immunity from claims. “Compliance with the refund statute is a condition precedent to availing oneself of the limited statutory waiver of sovereign immunity provided by the appeal statute [Conn. Gen. Stat. 12-730].” The requirement that a taxpayer timely pursue a refund comports with the “intertwined principles of sovereign immunity and exhaustion of administrative remedies.” Additionally, the statute specifically provides that the “[f]ailure to file a claim within the time prescribed in this section constitutes a waiver of any demand against the state on account of overpayment.” Thus, the failure to file a claim within the prescribed three year period under Conn. Gen. Stat. 12-732(a)(1) prevents the trial court from obtaining subject matter jurisdiction to consider that claim. The statutory scheme is jurisdictional is cannot be equitable tolled. Therefore, the Court directed the trial court to dismiss the taxpayer’s appeal to the Superior Court for lack of subject matter jurisdiction (and reverse the improper form of the judgment that had entered summary judgment in favor of the defendant on this issue).