Title: Kemppel v. Zaino

State: ohio

Issuer: Ohio Supreme Court

Document:

[Cite as Kemppel v. Zaino, 91 Ohio St.3d 420, 2001-Ohio-92.] 
 
 
 
KEMPPEL ET AL., APPELLANTS, v. ZAINO, TAX COMMR., APPELLEE. 
[Cite as Kemppel v. Zaino (2001), 91 Ohio St.3d 420.] 
Taxation — Income tax — Liquidation of assets of Ohio subchapter S corporation 
followed by dissolution of the corporation — Income from the gain on the 
sale of the intangible personal property not business income as defined in 
R.C. 5747.01(B) — Tax Commissioner’s remitting of portion of the statutory 
penalty is not an abuse of discretion. 
(No. 00-358 — Submitted February 27, 2001 — Decided May 23, 2001.) 
APPEAL from the Board of Tax Appeals, No. 98-K-698. 
__________________ 
 
ALICE ROBIE RESNICK, J.  In 1989 the assets of the Logan Machine Co. 
(“Logan”), an Ohio subchapter S corporation located in Akron, were liquidated and 
the corporation dissolved.  The net proceeds from the sale of the assets were 
distributed to the shareholders, including appellants, Russell and Carrie Kemppel,1 
who were residents of and domiciled in Florida at the time of the sale.  As 
shareholders of Logan, each of the Kemppels received his or her pro rata share of the 
net proceeds of the sale, including gain from the sale of intangible personal property, 
which was attributed to goodwill. 
 
To calculate the amount of their nonresident tax credit under R.C. 
5745.05(A), the Kemppels calculated the ratio of their non-Ohio income to their total 
income.  In calculating this ratio, the Kemppels included as non-Ohio income all 
income attributed to them from Logan, except that from ordinary business operations 
prior to the sale.  The Tax Commissioner audited the Kemppels’ return and treated all 
of the income attributed to them from Logan as business income and therefore subject 
to allocation to Ohio, including the gain from the sale of the intangible personal 
                                                          
 
1. 
On February 5, 2001, a suggestion of death was filed for Carrie M. Kemppel.  Russell E. 
Kemppel as administrator of the estate of Carrie M. Kemppel has been substituted as a party. 
SUPREME COURT OF OHIO 
2 
property (goodwill).  As a result, the ratio of the Kemppels’ non-Ohio income to total 
income was reduced, thereby reducing the amount of the Kemppels’ nonresident 
credit and increasing their Ohio tax.  The assessment issued by the commissioner 
included the statutory double interest penalty. 
 
The Kemppels filed for reassessment.  After a hearing, the commissioner 
affirmed his assessment; however, he reduced the statutory interest penalty by one-
half.  The Kemppels appealed the commissioner’s decision to the Board of Tax 
Appeals, which affirmed the assessment.  This cause is now before the court upon an 
appeal as of right. 
 
The Kemppels present two issues: (1) Is the income attributed to the 
Kemppels from the gain on the sale of intangible personal property, as a result of the 
liquidation of Logan, business or nonbusiness income? and (2) Did the Tax 
Commissioner abuse his discretion in not abating the entire statutory interest penalty? 
 
Because the Kemppels are shareholders in a subchapter S corporation, the 
character of the income attributed to them from Logan is determined as though they 
had received it directly from the same source as Logan.  Dupee v. Tracy (1999), 85 
Ohio St.3d 350, 708 N.E.2d 698; Section 1366(b), Title 26, U.S.Code.  Thus, if 
income is business income to Logan, it is business income to the Kemppels; if 
income is nonbusiness income to Logan, it is nonbusiness income to the Kemppels. 
 
Former R.C. 5747.21 provided: “All items of business income * * * shall be 
allocated to this state by [apportionment].”  Sub.H.B. No. 250, 140 Ohio Laws, Part I, 
2643.  R.C. 5747.20(B)(2)(c) provides that the nonbusiness income of a nonresident 
resulting from capital gains from the sale of intangible property is “allocable to this 
state if the taxpayer’s domicile was in this state at the time of such sale or other 
transfer.”  Since the Kemppels were not domiciled in Ohio at the time of the sale, 
none of their share of the income from the gain on the sale of the intangible personal 
property can be allocated to Ohio unless the income is classified as business income. 
 
R.C. 5747.01(B) and (C) define the terms “business income” and 
“nonbusiness income”: 
January Term, 2001 
3 
 
“(B) ‘Business income’ means income arising from transactions, activities, 
and sources in the regular course of a trade or business and includes income from 
tangible and intangible property if the acquisition, rental, management, and 
disposition of the property constitute integral parts of the regular course of a trade or 
business operation. 
 
“(C) ‘Nonbusiness income’ means all income other than business income and 
may include, but is not limited to, compensation, rents and royalties from real or 
tangible personal property, capital gains, interest, dividends and distributions, patent 
or copyright royalties, or lottery winnings, prizes, and awards.” 
 
The definition of “business income” set forth in R.C. 5747.01(B) is a 
modified version of the definition initially promulgated by the National Conference 
of Commissioners on Uniform State Laws in 1957, as part of its Uniform Division of 
Income for Tax Purposes Act (“UDITPA”).  The UDITPA definition was later 
adopted by the Multistate Tax Commission.  The same definition or a slightly 
modified version has been adopted by many states. 
 
Courts in other states have split in applying tests for classifying income.  
Some courts have applied the “transactional test,” and others have applied an 
additional distinct test, the “functional test.”  To facilitate discussion of these tests we 
have separated R.C. 5747.01(B) into two parts: 
 
Part I:  “ ‘Business income’ means income arising from transactions, 
activities, and sources in the regular course of a trade or business” 
 
and 
 
Part II: “includes income from tangible and intangible personal property if 
the acquisition, rental, management, and disposition of the property constitute 
integral parts of the regular course of a trade or business operation.” 
 
The transactional test, which the Kemppels urge us to adopt, considers the 
statute as a whole and emphasizes Part I of the definition.  It treats Part II as merely 
giving examples of income within Part I.  In this test the income is business or 
nonbusiness depending on whether it arises from a transaction or activity that occurs 
SUPREME COURT OF OHIO 
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in the regular course of the business in which the taxpayer engages.  The nature, 
frequency, and regularity of the transaction are relevant factors.  W. Natural Gas Co. 
v. McDonald (1968), 202 Kan. 98, 446 P.2d 781; Phillips Petroleum Co. v. Iowa 
Dept. of Revenue & Fin. (Iowa 1993), 511 N.W.2d 608; In re Uniroyal Tire Co. v. 
State Dept. of Revenue (Ala.2000), 779 So.2d 227.  In addition, some courts also look 
to see whether the proceeds of the transaction are used in the business or dispersed to 
shareholders. Union Carbide Corp. v. Huddleston (Tenn.1993), 854 S.W.2d 87, 93. 
 
The functional test, which the commissioner urges us to adopt, focuses on 
Part II, treating it as independent of Part I.  Under the functional test, business income 
includes income from sale of personal property if use of the property constituted an 
integral part of the regular course of a trade or business operation.  The Pennsylvania 
Supreme Court has stated, “Income meets the functional test if the gain arises from 
the sale of an asset which produced business income while it was owned by the 
taxpayer.”  Laurel Pipe Line Co. v. Commonwealth, Bd. of Fin. & Revenue (1994), 
537 Pa. 205, 210, 642 A.2d 472, 475.  Under the functional test, the extraordinary 
nature or infrequency of the transaction is irrelevant. 
 
Nevertheless, some courts that have adopted the functional test have also 
recognized that the sale of assets as part of the total or partial liquidation of a business 
is different from the sale of assets by a continuing business.  In Polaroid Corp. v. 
Offerman (1998), 349 N.C. 290, 306, 507 S.E.2d 284, 296, although the North 
Carolina Supreme Court recognized the functional test, it noted, in footnote six, 
“[C]ases involving liquidation are in a category by themselves.  Indeed true 
liquidation cases are inapplicable to these situations because the asset and transaction 
at issue are not in furtherance of the unitary business, but rather a means of 
cessation.”  Likewise, in Laurel Pipe Line Co., the Pennsylvania Supreme Court, 
while recognizing the functional test, held that the partial liquidation of a company’s 
business by the sale of a pipeline that had been idle for over a year “was not disposed 
of as an integral part” of the company’s regular trade or business and, therefore, was 
not business income.  Id., 537 Pa. at 211, 642 A.2d at 475. 
January Term, 2001 
5 
 
After reviewing these authorities we find that we do not need to determine 
which test is applicable to decide this case.  The income received by Logan was not 
business income under either the transactional test or the functional test.  The income 
in question resulted from a liquidation of assets followed by a dissolution of the 
corporation; this was a one-time event that terminated the business.  This was no sale 
in the regular course of a trade or business.  Therefore, the income from the gain on 
the sale of the intangible personal property was not “business income” as defined in 
R.C. 5747.01(B). 
 
Next the Kemppels contend that the Tax Commissioner abused his discretion 
by failing to abate the entire statutory penalty.  The penalty was based on assessments 
that the Kemppels no longer dispute, as well as on the assessment that we have 
determined to be improper.  Obviously the portion of the penalty related to the 
improper assessment must be abated.  The Kemppels seek abatement of the entire 
penalty because their failure to pay the proper amount of tax was based on the advice 
of a national accounting firm. 
 
R.C. 5747.15(A)(2) provides that if a taxpayer fails to pay the amount of tax 
required, “a penalty shall be imposed equal to twice the interest charged under 
division (G) of section 5747.08 of the Revised Code for the delinquent payment.”  
R.C. 5747.15(C) provides: “All or part of any penalty imposed under this section may 
be abated by the commissioner if the taxpayer shows that the failure to comply with 
the provisions of this chapter is due to reasonable cause and not willful neglect.”  The 
Tax Commissioner, here, has abated one-half the statutory penalty. 
 
The Kemppels failed to present any evidence to substantiate their claim that 
the Tax Commissioner abused his discretion as to the assessments that they no longer 
dispute.  In prior cases this court has held that its review of the commissioner’s 
discretionary power to remit a penalty is limited to whether an abuse of discretion has 
occurred.  Jennings & Churella Constr. Co. v. Lindley (1984), 10 Ohio St.3d 67, 10 
OBR 357, 461 N.E.2d 897.  This matter is remanded to the Tax Commissioner to 
SUPREME COURT OF OHIO 
6 
exercise his discretion to reassess the penalty related to the assessments the Kemppels 
no longer dispute. 
Decision affirmed in part, 
reversed in part 
and cause remanded. 
 
MOYER, C.J., F.E. SWEENEY, PFEIFER, COOK and LUNDBERG STRATTON, JJ., 
concur. 
 
DOUGLAS, J., dissents. 
__________________ 
 
Witschey & Witschey Co., L.P.A., Jeffrey T. Witschey and Frank J. Witschey, 
for appellants. 
 
Betty D. Montgomery, Attorney General, and Robert C. Maier, Assistant 
Attorney General, for appellee. 
 
Jones, Day, Reavis & Pogue and Charles M. Steines, urging reversal for 
amicus curiae Lewis W. Dickey. 
 
Taft, Stettinius & Hollister, L.L.P., and Stephen M. Nechemias, urging 
reversal for amici curiae David S. and Linda K. Paresky. 
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