87 Ohio St.3d 265
Submitted September 21, 1999
Appeals from the Board of Tax Appeals, Nos. 96-R-302, 96-R-301 and 96-R-303.
Timmis & Inman L.L.P., George M. Malis and Erich J. D'Andrea, pro hac vice, for appellants.
Betty D. Montgomery, Attorney General, and Robert C. Maier, Assistant Attorney General, for appellee.
This matter involves three cases consolidated for review: James R. Agley v. Tracy, No. 98-1879; Randolph J. and Judith A. Agley v. Tracy, No. 98-1880; and Michael T. and Nancy E. Timmis v. Tracy, No. 98-1881. All appellants seek refunds on taxes paid on their respective distributive share income generated by Subchapter S corporations. Appellant James Agley seeks a refund for taxes he paid in the tax years of 1989, 1990, 1991, and 1992. Appellants Randolph and Judith Agley and appellants Michael and Nancy Timmis seek a refund for taxes paid in the tax years of 1988, 1989, 1990, 1991, and 1992.
During these tax years, all the appellants were shareholders in the following corporations: F & M Distributors, Inc., Venture Packaging, Inc., and Diamond Automations, Inc. James Agley was also a shareholder in Middletown Aerospace. Appellants elected these corporations to be Subchapter S corporations for federal income tax purposes, pursuant to Subchapter S, Chapter 1, of Subtitle A of the Internal Revenue Code of 1986. These corporations were organized and existed in Michigan and conducted business in Ohio. Appellants were not residents of, or domiciled within, Ohio during the disputed tax years. Appellants did not personally conduct any business within Ohio during the disputed tax years.
For the disputed tax years, appellants included their pro-rata share of S corporation income or loss generated by the S corporations in their federal adjusted gross income. Appellants paid individual income tax to Ohio on their distributive share income generated by the S corporations.
Appellants applied to appellee, Tax Commissioner, for personal income tax refunds for the disputed tax years. James Agley sought $9, 942 in refunds, Randolph and Judith Agley sought $42, 043 in refunds, and Michael and Nancy Timmis sought $41, 003 in refunds. The Tax Commissioner denied the applications. The appellants appealed to the Board of Tax Appeals, which in each case affirmed the commissioner's order denying a refund.
These causes are now before this court upon appeals of right.
Lundberg Stratton, J.
The appellants assert five propositions of law in support of their contention that an out-of-state shareholder should not be taxed in Ohio on the distributive share of income he or she receives from his or her S corporation that is doing business in Ohio. For the following reasons, we disagree. Thus, we affirm the Board of Tax Appeals in each case.
Appellants argue that nonresident shareholders of an S corporation that conducts business activities in Ohio should not be subject to income tax on their distributive share of the S corporation's income under R.C. 5747.02 because it is the S corporation that earns the income, not the shareholder. We recently rejected this argument in Dupee v. Tracy (1999), 85 Ohio St.3d 350, 351, 708 N.E.2d 698, 700, because this position ignores the "flow through" nature of an S corporation, whereby business income generated by the S corporation flows directly through to the shareholder for taxation purposes. Applying Dupee, we find appellants' first proposition meritless.
Appellants also argue that taxation of nonresident shareholders of an S corporation violates their due process rights because they do not have a "substantial nexus" with Ohio. Initially, we note that appellants misstate the test for determining whether due process has been violated. Substantial nexus is the test used to determine whether a tax violates the Commerce Clause. See Quill Corp. v. North Dakota (1992), 504 U.S. 298, 313, 112 S.Ct. 1904, 1913-1914, 119 L.Ed.2d 91, 107. The Due Process Clause "requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax." Miller Bros. Co. v. Maryland (1954), 347 U.S. 340, 344-345, 74 S.Ct. 535, 539, 98 L.Ed. 744, 748. In other words, a state must have minimum contacts with the entity ...