Mandell v. Utah Tax Comm.

2008 UT 34
This opinion is subject to revision before final
publication in the Pacific Reporter.
IN THE SUPREME COURT OF THE STATE OF UTAH
----oo0oo----
Dennis Mandell and Kathy Mandell, 	No. 20060521
Petitioners,
v.
Auditing Division of the 	F I L E D
Utah State Tax Commission,
Respondent. 	May 23, 2008
---
Original Proceeding in this Court.
Attorneys: 	David W. Scofield, Thomas W. Peters, Salt Lake City,
for petitioners
Mark L. Shurtleff, Att’y Gen., Timothy A. Bodily,
Asst. Att’y Gen., Salt Lake City, for respondent
---
PARRISH, Justice:
INTRODUCTION
¶1 	This petition for review asks us to determine whether
the state of Utah has the authority to tax the proceeds of a
settlement received by Dennis Mandell and his wife, Kathy (the
“Mandells”). 	The settlement resolved a lawsuit that Dennis
Mandell (“Mandell”) filed in Nevada some two years after he and
Kathy moved from Utah. 	The Auditing Division of the Utah State
Tax Commission (the “Auditing Division”) determined that the
settlement proceeds were taxable because they related to the sale
of assets of an S corporation doing business in Utah. 	As a
result, the Auditing Division assessed a delinquency on the 2001
joint tax return filed by the Mandells. 	The Mandells
unsuccessfully appealed that determination to the Utah State Tax
Commission (the “Commission”) and then filed a petition for
review with this court. 	We affirm the Commission’s
determination. 	The settlement proceeds were paid in lieu of
proceeds that Mandell should have received from the sale of
assets of a Utah corporation. 	Because the proceeds of the
original sale were taxable, the settlement is also taxable.

No. 20060521 	2
BACKGROUND
¶2 	The Mandells were residents of Utah from 1995 to March
1999. 	During that time, Dennis Mandell was the manager and a 20%
shareholder of Homes America of Utah, Inc. (“HAU”), a company
that sold mobile homes in Utah. 	HAU filed as a subchapter S
corporation for federal income tax purposes. 	In addition to
Mandell, HAU had two other shareholders: 	Gerald Meyer owned 20%
and Eugene Whitworth (“Whitworth”) owned 60%.
¶3 	Whitworth also controlled eight other corporations that
were in the business of selling mobile homes. 	These other
corporations operated in Nevada, Arizona, Idaho, Oklahoma,
California, and Oregon. 	In 1998, Whitworth agreed to sell all
nine corporations to Champion Homes, Inc. (“Champion”) for an
aggregate purchase price of $102.5 million. 	Of the aggregate
purchase price, Champion paid $67.5 million in cash, with $5
million held in reserve for eighteen months to cover unknown
liabilities. 	The remaining $30 million was payable contingent
upon the combined future earnings of the corporations. 	Whitworth
used his discretion to allocate the aggregate purchase price
among the nine corporations. 	The sale was consummated on March
27, 1998, but the contingent component of the purchase price was
never realized.
¶4 	Mandell and the other shareholders of HAU elected to
treat the sale as a “deemed asset sale” by filing an election
under section 338(h)(10) of the Internal Revenue Code (the
“section 338 election”). 	As a result, the transaction was
treated for tax purposes as though HAU had sold assets and
distributed the sale proceeds to its shareholders. 	See I.R.C.
§ 338(h)(10) (2000). 	The shareholders in the other eight
Whitworth corporations similarly made section 338 elections. 	HAU
reported the gain from the sale as business income apportioned
100% to Utah on its 1998 Utah income tax returns. 	It also
identified Utah as its “commercial domicile.”
¶5 	In 1999, approximately one year after the sale of HAU,
the Mandells moved to Nevada. 	Shortly thereafter, Mandell
discovered that Whitworth had defrauded him in connection with
the sale by characterizing the sale proceeds in a manner that
disproportionately benefitted Whitworth. 	Whitworth allocated
between 80% and 100% of the cash component to those corporations
that he wholly owned, while allocating a higher percentage of the
contingent payments to those corporations with minority
shareholders. 	As a result of this disparate allocation,
Whitworth was able to substantially underpay the minority
shareholders.

1 Whitworth passed away in November 1998. 	Because the fact
of Whitworth’s death is not material to our analysis, we will
refer to Whitworth’s estate simply as “Whitworth.”
3 	No. 20060521
¶6 	For example, Whitworth allocated $8.105 million of the
total $102.5 million purchase price to the sale of HAU. 	Of this
allocation, however, only 38% (or $3.105 million) was paid
through the cash component of the purchase price, with 62% (or $5
million) deferred as an unrealized contingency. 	This meant that
Mandell received only $621,000, instead of approximately $1.67
million he would have received had the various components of the
purchase price (i.e., cash, deferred, and contingent payments)
been proportionately distributed among the various corporations.
¶7 	After discovering Whitworth’s underpayment, Mandell
filed suit in a Nevada state court against Whitworth’s estate. 1
Mandell’s complaint alleged that Whitworth had inflated the
values of the corporations of which he was the sole shareholder
or in which he owned a relatively large percentage of shares,
thereby artificially decreasing the value of Mandell’s ownership
in HAU. 	Mandell sought imposition of a constructive trust on the
misallocated sales proceeds. 	He also requested general damages,
attorney fees, and interest on the amounts due.
¶8 	Whitworth and Mandell settled the Nevada lawsuit in
2001. 	In return for a settlement payment, Mandell and his wife,
Kathy, released and discharged all claims alleged in the
complaint. 	The Mandells received $1,127,977 through the
settlement, which increased the total amount that Mandell
received from the sale of HAU to $1,748,077--approximately
$78,000 more than the principal amount Mandell should have
received originally. 	The parties documented their settlement in
a “Confidential Settlement Agreement.”
¶9 	The way the parties characterized their settlement is
important. 	On their federal income tax return, the Mandells
reported the settlement proceeds as a long-term capital gain from
the sale of Mandell’s “20% stock interest of [HAU], sold on
9/15/01.” 	The Mandells’ accountant, Kenneth Stieha, explained
that the settlement was reported as capital gain (not ordinary
income) on the Mandells’ 2001 federal income tax return because
the proceeds related back to the initial sale of HAU and the
section 338 election. 	Whitworth similarly treated the settlement
as an adjustment to the HAU sale, seeking reimbursement under a
claim of right credit on his 2001 federal income tax return by
offsetting the settlement proceeds paid to the Mandells against
the income reported from the sale in 1998. 	Whitworth also
attempted to file an amended 1998 Utah state income tax

No. 20060521 	4
return--reducing the gain recognized from the sale of his stock
in HAU by the amount of the settlement paid to the Mandells in
2001. 	Although the Commission initially challenged Whitworth’s
position, the Commission and Whitworth eventually reached a
settlement.
¶10 	In 2003, the Auditing Division assessed a deficiency on
the Mandells’ 2001 tax return for $70,129.62, as well as
penalties of $14,025.92 and interest amounting to $6,148.00. 	The
Mandells appealed. 	On appeal, the Commission waived the
penalties but upheld the deficiency, after finding that the
settlement was paid in lieu of proceeds Mandell should have
received from the original sale. 	The Mandells thereafter
petitioned this court for review of the Commission’s decision.
We have jurisdiction pursuant to Utah Code section 78A-3-
102(3)(e)(ii) (2008).
STANDARD OF REVIEW
¶11 	When reviewing the Commission’s formal adjudicative
proceedings, we grant no deference to the Commission’s
conclusions of law, reviewing them for correctness. 	Utah Code
Ann. § 59-1-610(1)(b) (2006); see also Kennecott Corp. v. State
Tax Comm’n, 858 P.2d 1381, 1383 (Utah 1993). 	We do, however,
grant deference to the Commission’s written findings of fact,
applying the “substantial evidence standard” on review. 	Utah
Code Ann. § 59-1-610(1)(a).
¶12 	Our standard of review for mixed questions of law and
fact varies “according to the nature of the legal concept at
issue.” 	State v. Levin, 2006 UT 50, ¶ 21, 144 P.3d 1096. 	To
determine the standard of review for a mixed question of law and
fact, we apply a test that considers (1) the complexity of the
facts; (2) the degree to which the lower court relied on
observable facts that cannot be adequately reflected in the
record, such as witness demeanor and appearance; and (3) any
policy reasons favoring or disfavoring the exercise of
discretion. 	Id. ¶ 25.
ANALYSIS
¶13 	The Mandells characterize the 2000 lawsuit as a chose-
in-action litigated entirely in Nevada, deriving from a fraud
that occurred in California. 	Because they were not Utah
residents at the time of the 2001 settlement, the Mandells
contend that Utah lacks jurisdiction to tax the settlement
proceeds.

5 	No. 20060521
¶14 	The fact that the Mandells had no personal, commercial,
or business presence in Utah in 2001 does not render them immune
from taxation by the state of Utah. 	“[T]he power to promulgate
and enforce income tax laws is an essential attribute of
sovereignty.” 	Franchise Tax Bd. v. Hyatt, 538 U.S. 488, 498
(2003) (citing Franchise Tax Bd. v. U.S. Postal Serv., 467 U.S.
512, 523 (1984)). 	In order to tax, a state must show only “some
definite link, some minimum connection, between a state and the
person, property or transaction it seeks to tax.” 	Miller Bros.
Co. v. Maryland, 347 U.S. 340, 344-45 (1954). 	Among other
things, “incorporation by a state or permission to do business
there forms the basis for proportionate taxation of a company.”
Id. at 345 (footnotes omitted).
¶15 	The Mandells’ claim that Utah lacks authority to tax
their settlement proceeds presents an issue of first impression
in Utah. 	Other courts, however, have had ample opportunity to
determine a state’s authority to tax settlement proceeds or
damages received through litigation. 	These courts uniformly look
to the character and nature of the settlement proceeds or damages
to determine their taxability, asking “in lieu of what were the
damages awarded”? 	See, e.g., Dye v. United States, 121 F.3d
1399, 1404, 1409 (10th Cir. 1997); Alexander v. IRS, 72 F.3d 938,
942 (1st Cir. 1995); Gail v. United States, 58 F.3d 580, 582
(10th Cir. 1995); Raytheon Prod. Corp. v. Comm’r, 144 F.2d 110,
113 (1st Cir. 1944); Connolly v. Comm’r, 93 T.C.M. (CCH) 1138,
1139 (2007); Pennzoil Co. v. Dep’t of Revenue, 33 P.3d 314, 317
(Or. 2001). 	This test recognizes that where profits would be
subject to taxation, “the proceeds of litigation which are their
substitute are taxable in like manner.” 	Raytheon, 144 F.2d at
113.
¶16 	In light of persuasive case law from other
jurisdictions, we hold that the Commission appropriately adopted
and applied the “in lieu of” test to determine the true character
and nature of the settlement proceeds. 	We further hold that the
Commission appropriately concluded that the proceeds at issue
were received in lieu of sale proceeds that were taxable by the
state of Utah.
I. 	UNDER THE “IN LIEU OF” TEST, THE
SETTLEMENT PROCEEDS RELATE TO THE ORIGINAL
SALE OF HAU, WHICH WAS SUBJECT TO UTAH TAX
A. 	Determining the Character and Nature of the Settlement
Proceeds Presents a Mixed Question of Law and Fact

No. 20060521 	6
¶17 	Determining the true character and nature of the
settlement proceeds presents a mixed question of law and fact,
not a mere question of fact as the Division suggests. 	Because
the determination of the character and nature of such proceeds is
typically outcome determinative, it deserves a more thorough
review than clear error. 	Cf. Bose Corp. v. Consumers Union of
U.S., Inc., 466 U.S. 485, 500-01 (1984) (according less
deferential review to findings of “ultimate facts” which “may
determine the outcome of litigation”).
¶18 	In State v. Levin, we set out a policy-based balancing
test for determining the amount of deference that appellate
courts should pay to trial courts when reviewing mixed questions
of law and fact. 	2006 UT 50, ¶ 25, 144 P.3d 1096. 	The
tripartite test considers (1) the complexity of the facts; (2)
the degree to which the trial court relied on observable facts
that cannot be reflected adequately in the record, such as
witness demeanor and appearance; and (3) policy reasons that
favor the exercise of discretion by the lower courts. 	Id. ¶ 25.
¶19 	In this case, all three factors favor application of a
less deferential standard of review. 	First, the facts are
straightforward and uncomplicated. 	Second, they are reviewable
from the cold record, requiring little reliance on witness
demeanor. 	For example, the nature of the allegations in the
underlying lawsuit, Whitworth’s assertion of the claim of right,
and the Mandells’ characterization of the settlement proceeds on
their 2001 federal income tax return are all facts memorialized
in a written record. 	Third, although we are not aware of a
particular demand for consistency in this area of the law, other
policy reasons support a less deferential standard of review.
Most importantly, application of the “in lieu of” test implicates
due process because it is the state’s jurisdictional hook for
taxing the Mandells’ settlement proceeds.
¶20 	We conclude that the character and nature of a
settlement or judgment under the “in lieu of” test presents a
mixed question of law and fact and that the three Levin factors
weigh in favor of according less deference to the Commission’s
application of the law to the facts. 	A finding of fact may
occasionally be
inseparable from the principles through which
it was deduced. 	At some point, the reasoning
by which a fact is “found” crosses the line
between application of those ordinary
principles of logic and common experience
. . . into the realm of a legal rule upon

7 	No. 20060521
which the reviewing court must exercise its
own independent judgment.
Bose Corp., 466 U.S. at 501 n.17.
¶21 	With the appropriate standard of review in mind, we
proceed to the two-step analysis pursuant to which we determine
whether there is a sufficient connection for Utah to tax the
settlement proceeds. 	We first determine the character and nature
of the settlement proceeds by asking, “In lieu of” what was the
settlement paid? 	See, e.g., Dye v. United States, 121 F.3d 1399,
1409 (10th Cir. 1997); Pennzoil Co. v. Dep’t of Revenue, 33 P.3d
314, 317 (Or. 2001). 	Once we have determined the character and
nature of the settlement, we then analyze whether it constitutes
income taxable by the state of Utah.
B. 	Applying the “In Lieu of” Test Demonstrates
That the Settlement Related to the Original Sale of HAU
¶22 	Because the taxability of a settlement or judgment is
dependent upon the underlying transaction or claim, we apply the
“in lieu of” test to determine what the settlement proceeds or
damages replaced. 	Although Utah courts have yet to apply the
test, a host of cases from other jurisdictions provide guidance
as to the relevant factors. 	Specifically, we consider the intent
of the parties as indicated by express language in the settlement
agreement or by circumstances surrounding the settlement, the
parties’ own characterization of the settlement proceeds, the
language of the complaint, and the amount of the settlement. 	We
apply these factors to this case by looking at Whitworth’s
apparent intent in settling the claim, Mandell’s own
characterization of the suit, the Mandells’ treatment of the
settlement proceeds, and the amount of the settlement.
1. 	Whitworth’s Intent in Settling the Claim
¶23 	The intent of the payor in settling a claim is one of
the most important considerations in determining the underlying
nature of a settlement. 	See Knuckles v. Comm’r, 349 F.2d 610,
613 (10th Cir. 1965) (holding that settlement proceeds were not
for personal injury claim where the payor did not acknowledge
possible liability for personal injury and in fact consistently
denied such liability); Hawkins v. Comm’r, 94 T.C.M. (CCH) 310,
312 (2007) (“We determine the reason for the settlement payment
by ascertaining the intent of the payor in making the payment.”).
¶24 	Typically, the intent of the payor is determined from
the language of the settlement agreement. 	In this case, however,

2 A claim of right deduction is allowed when, after a
previous payment of taxes on an income amount in a prior year,
the taxpayer discovers in a later year that the income amount was
actually lower than previously thought. 	Because the taxpayer has
been overtaxed, the taxpayer files for a refund based on
overpayment when the mistake or error comes to light. 	See I.R.C.
§ 1341(a) (2000).
3 The Mandells argue that Whitworth should not have been
entitled to a federal claim of right deduction due to fraud. 	See
Kraft v. United States, 991 F.2d 292 (6th Cir. 1993). 	We,
however, are not concerned with the validity of Whitworth’s claim
of right deduction--only his state of mind. 	And the fact that
the settlement prompted Whitworth to file a claim of right to
adjust the amount of the proceeds subject to tax in connection
with the original sale indicates that the settlement was intended
to reflect an adjustment in the amount of the sale proceeds to
which Mandell was entitled in connection with the original sale.
No. 20060521 	8
the settlement agreement was confidential. 	The parties have not
provided us with complete copies of the settlement, and the
portion contained in the record is silent as to Whitworth’s
intent. 	In such cases, other courts have looked to the factual
circumstances surrounding the settlement to determine the payor’s
intent. 	See, e.g., Gibson v. Comm’r, 94 T.C.M. (CCH) 164, 167
(2007); Connolly v. Comm’r, 93 T.C.M. (CCH) 1138, 1140 (2007).
¶25 	In this case, Whitworth’s tax filings indicate that
Whitworth intended the settlement to compensate the Mandells for
amounts wrongfully withheld in connection with the original sale
of HAU. 	Whitworth asserted a claim of right 2 on his 2001 federal
income tax return. 3 	The claim of right sought reimbursement for
the tax that Whitworth paid in 1998 on the inflated amount he
received in connection with the original sale. 	Whitworth sought
a similar adjustment from the state of Utah. 	Whitworth’s
assertion of these claims reflects his intention that the
settlement reimburse the Mandells for proceeds that Mandell
should have received in connection with the original sale.

4 Only Mandell was a party to the lawsuit. 	Nevertheless,
both Dennis and Kathy signed the settlement agreement.
Accordingly, we refer to the Mandells’ settlement proceeds, but
to Mandell’s lawsuit or proceeds that Mandell should have
received from the sale.
9 	No. 20060521
2. 	Mandell’s Own Characterization of the Suit 4
¶26 	Another factor often considered in determining the
character of settlement proceeds obtained through litigation is
the language of the underlying complaint. 	See Elliott v. Comm’r,
53 T.C.M. (CCH) 1302, 1304 (1987) (considering a plaintiff’s
characterization in the complaint in concluding that settlement
was for lost profits); see also Villaume v. United States, 616 F.
Supp. 185, 189 (D. Minn. 1985) (rejecting argument that
settlement received was for personal injuries because the
complaint in state court “contained no indication that the suit
was intended to recover damages for personal injuries”); Estate
of Taracido v. Comm’r, 72 T.C. 1014, 1022 (1979) (“[T]he proper
test to be applied . . . is that the tax character of the
settlement proceeds is determined by the nature of the claims
involved and the basis of the recovery.”). 	In cases where the
underlying lawsuit has advanced to trial, courts have also looked
at evidence introduced and arguments made at trial. 	See Church
v. Comm’r, 80 T.C. 1104, 1107 (1983); see also State Fish Corp.
v. Comm’r, 48 T.C. 465, 474-76 (1967), clarified by 49 T.C. 13
(1967).
¶27 	Mandell’s complaint and the documents filed in
connection with his motion for summary judgment demonstrate that
Mandell filed suit for the purpose of recovering the proceeds
that he should have received from the 1998 sale of HAU. 	The
complaint states:
[Mandell has] discovered that the allocations
of the purchase price fixed by [Whitworth]
for each corporation were not based upon the
actual values of each corporation compared to
the total purchase price offered by
[Champion]. 	Instead, [Whitworth’s]
allocations inflated the values of those
companies that he exclusively owned or where
he had a larger percentage of ownership.
These allocations decreased the true value of
[Mandell’s] ownership in [HAU].

No. 20060521 	10
The complaint further alleges:
[Whitworth] also allocated a substantially
larger percentage of the cash portion of the
purchase price to himself as compared to the
cash paid to [Mandell]. 	[Mandell was] left
relying upon achieving the uncertain
performance criteria for the bulk of [his]
allocated purchase price.
¶28 	Similarly, in connection with his motion for summary
judgment, Mandell alleged that “Whitworth’s actions caused him to
sell his interests at a value substantially below their fair and
equitable share of the purchase price paid by Champion. 	In
addition Whitworth paid himself a disproportionate share of the
cash portion of the sales price.”
¶29 	In short, it is clear from the language of the
complaint and documents filed in connection with Mandell’s motion
for summary judgment that Mandell sought reimbursement for the
misallocated HAU sale proceeds. 	Although the complaint states
causes of action for breach of fiduciary duties, fraud, undue
influence, and unjust enrichment, the primary relief it requests
is a constructive trust on the funds that Whitworth received by
disproportionately allocating the sale proceeds.
3. 	Other Factors Demonstrating the Parties’ Intent Regarding the
Settlement Proceeds
¶30 	Other evidence also indicates that the Mandells viewed
the settlement proceeds as income from the sale of HAU. 	The
first such evidence is the Mandells’ treatment of the proceeds on
their 2001 federal income tax return, on which they reported the
settlement as a long-term capital gain on the sale of Mandell’s
20% interest in HAU. 	Similarly, the testimony of the accountant
who prepared the return established that the settlement proceeds
were treated as capital gains, rather than ordinary income,
because they were earnings from the deemed asset sale in 1998.
¶31 	The second such evidence is the amount of the
settlement payment. 	The settlement amount is similar to the
amount Mandell would have received in 1998 had Whitworth paid the
amount Mandell contends was owing. 	While Mandell should have
received $1,671,000 from the original sale of HAU, he received
only $621,000. 	The settlement proceeds of $1,127,977 increased
the total proceeds received to $1,748,977, just slightly more
than the amount to which Mandell was originally entitled. 	This
similarity between the two amounts further suggests that the

11 	No. 20060521
proceeds were received in lieu of amounts payable in connection
with the original sale of HAU. 	See Sager Glove Corp. v. Comm’r,
311 F.2d 210, 212 (7th Cir. 1962) (considering fact that recovery
sought for lost profits “closely approximated the settlement
amount” in determining the character and nature of the
settlement).
¶32 	In summary, having applied the “in lieu of” test, we
conclude that the settlement proceeds were paid in lieu of the
funds that Mandell should have received from the 1998 sale of
HAU. 	The Mandells’ attempt to distinguish the settlement
proceeds from the original sale is unavailing. 	Whitworth’s
apparent intent, Mandell’s characterization of his claim in the
underlying litigation, the Mandells’ treatment of the settlement
on their federal income tax return, and the amount of the
settlement are all consistent with the Commission’s determination
that the settlement was paid to reimburse the Mandells for the
proceeds Mandell should have received in connection with the
original sale of HAU.
II. 	UTAH HAS STATUTORY AUTHORITY TO TAX THE
SETTLEMENT BECAUSE IT WAS RECEIVED IN LIEU OF
PROCEEDS FROM THE SALE OF UTAH ASSETS
¶33 	Having determined that the settlement proceeds were
received in lieu of proceeds that Mandell should have received
from the sale of HAU, we now consider whether the state of Utah
had authority to tax the proceeds of the original sale. 	The
Commission’s decision offered three statutory sources of
authority to tax the sale proceeds, but even one source of
authority is sufficient. 	We hold that Utah had authority to tax
the proceeds of the original sale because those proceeds fall
within the statutory definition of Utah source income.
¶34 	Utah has authority to tax all Utah source income. 	Utah
source income is income derived from or connected to the state.
See Utah Code Ann. § 59-10-117 (2006). 	A corporation is deemed
to have subjected itself to Utah state taxing authority in return
“for the privilege of exercising its corporate franchise or for
the privilege of doing business in the state.” 	Id. § 59-7-
104(1). 	Consistent with this principle, the state of Utah
possesses the authority to tax nonresidents for the portion of
their income derived from Utah sources. 	See id. §§ 59-10-116,
-117.
¶35 	When a corporation is organized as an S corporation for
federal income tax purposes, the income it earns is passed
through and taxed to the shareholders based on their

5 Under the Utah Code, there is a rebuttable presumption
that the gain from a deemed asset sale constitutes business
income. 	Utah Code Ann. § 59-7-114(4). 	The Mandells cannot rebut
this presumption because when HAU initially reported the sale, it
characterized the sale as business income 100% apportioned to
Utah. 	Thus, the proceeds received by Mandell from the sale of
HAU were initially taxable as business income.
No. 20060521 	12
proportionate share of ownership. 	See I.R.C. §§ 1363, 1366
(2000); Robinson v. United States, 335 F.3d 1365, 1366 (Fed. Cir.
2003) (“The tax consequences of an S-corporation flow through to
the shareholders, so the shareholders recognize the corporation’s
income and expenses on their individual tax returns.”). 	For
purposes of determining whether this passed-through income is
taxable, the character of the income remains the same as it was
when in the hands of the corporation. 	See I.R.C. § 1366(b).
Because Utah taxes S corporations in the same manner as they are
taxed for federal tax purposes, a nonresident shareholder of an S
corporation must pay taxes on the portion of an S corporation’s
taxable income derived from Utah sources. 	Utah Code Ann. §§ 59-
7-701, -702(2)(b).
¶36 	The proceeds from the sale of HAU constituted Utah
source income. 	HAU was an S corporation doing all of its
business in Utah. 	Thus, all of the income received by HAU in the
ordinary course of business, which was passed through to its
shareholders, was derived from Utah sources.
¶37 	The structure of the HAU sale further demonstrates that
the sale proceeds were Utah source income. 	All of HAU’s
shareholders elected to characterize the sale as a deemed asset
sale under I.R.C. § 338(h)(10). 	As a result, the gains realized
through the sale were taxable as if the corporation had sold
assets rather than stock. 	See id. § 338(h)(10). 	The gains from
the sale passed through to the shareholders, who bore the
responsibility of paying taxes on those gains in proportion to
their ownership interests. 	See id. § 1366(b); see also Utah Code
Ann. § 59-7-701. 	The gains recognized from this deemed asset
sale constitute Utah source income under Utah Code sections 59-
10-118(1)(a), which defines business income, and 59-7-114(4),
which creates a rebuttable presumption that the gain on a deemed
sale of assets under a section 338 election constitutes business
income. 5 	They are therefore taxable under Utah Code section 59-
10-117(2)(d).
¶38 	Because the 2001 settlement proceeds were received in
lieu of the original sale proceeds and because the original sale

13 	No. 20060521
proceeds were taxable as Utah source income, the settlement
proceeds are also taxable as Utah source income. 	And they remain
taxable whether or not the shareholders are residents of Utah.
¶39 	Case law supports the right of a state to tax a
nonresident shareholder on the income of an S corporation derived
from that state. 	For example, in Isaacson v. Iowa State Tax
Commission, Nebraska residents, who were shareholders of an Iowa
S corporation that conducted all of its business in Iowa,
challenged Iowa’s authority to tax the corporate income that
passed through to them. 	183 N.W.2d 693, 693-94 (Iowa 1971).
During the years for which the Isaacsons were taxed in Iowa, the
Isaacsons conducted no business or trade activities there. 	Id.
at 694. 	Construing statutes similar to those at issue here, the
Iowa Supreme Court held that Iowa could tax the S corporation’s
dividends received by the nonresident Isaacsons. 	Id. at 695.
Other courts have decided this issue similarly. 	See, e.g.,
Valentino v. Franchise Tax Bd., 105 Cal. Rptr. 2d 304 (Ct. App.
2001) (holding that S corporation shareholders are liable for
California taxes based on the income earned by the S corporation
through income producing activities within the state); Gen.
Accessory Mfg. Co. v. Okla. Tax Comm’n, 2005 OK CIV APP 75, ¶ 13,
122 P.3d 476, 480 (holding that nonresident stockholders who made
a section 338 election in the sale of their stock were liable for
Oklahoma income tax because the corporation was domiciled in the
state and derived all of its income from sources within the
state); Kulick v. Dep’t of Revenue, 624 P.2d 93, 98-99 (Or. 1981)
(holding that Oregon could constitutionally tax personal income
of a nonresident shareholder of an S corporation based on
distributed and undistributed income).
¶40 	In summary, the settlement proceeds are taxable by Utah
because they relate to the sale of Utah assets. 	Gains received
from such a sale are clearly taxable under the Utah Code. 	It is
of no import that the Mandells did not receive the sale proceeds
until after they moved to Nevada because Utah may tax the income
of nonresidents if that income is derived from this state.
III. 	THE DEFICIENCY ASSESSED AGAINST THE MANDELLS DOES
NOT VIOLATE THE UNITED STATES CONSTITUTION
¶41 	The Mandells argue that Utah’s taxation of the
settlement proceeds violates the United States Constitution.
When challenging the authority of a state to impose a tax, “[t]he
party attacking the constitutionality of a statute has the burden
of affirmatively demonstrating that the statute is
unconstitutional. 	Moreover, there is a strong presumption that
tax statutes are constitutional.” 	Kennecott Corp. v. State Tax

6 The Court added that the taxpayer’s “‘burden is never met
merely by showing a fair difference of opinion which as an
original matter might be decided differently.’” 	Id. at 176
(quoting Norton Co. v. Dep’t of Revenue, 340 U.S. 534, 537-38
(1951)).
No. 20060521 	14
Comm’n, 858 P.2d 1381, 1384 (Utah 1993) (footnotes omitted). 	The
United States Supreme Court has recognized that “the taxpayer has
the distinct burden of showing by clear and cogent evidence that
[the state tax] results in extraterritorial values being taxed.” 6
Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159, 164
(1983) (internal quotation omitted).
¶42 	States have broad constitutional authority to impose
taxes on transactions within their borders, but no state has
authority to “tax value earned outside its borders.” 	ASARCO,
Inc. v. Idaho Tax Comm’n, 458 U.S. 307, 315 (1982). 	In Wisconsin
v. J.C. Penney Co., the Supreme Court noted that
[a] state is free to pursue its own fiscal
policies, unembarrassed by the Constitution,
if by the practical operation of a tax the
state has exerted its power in relation to
opportunities which it has given, to
protection which it has afforded, to benefits
which it has conferred by the fact of being
an orderly, civilized society.
311 U.S. 435, 444 (1940). 	The Court went on to note that “[t]he
substantial privilege of carrying on business” within state
borders “clearly supports” taxation. 	Id. at 444-45.
¶43 	The Mandells first challenge Utah’s taxing authority
under the Due Process Clause of the United States Constitution.
To withstand a due process challenge to the imposition of a tax,
a “definite link” or “minimum connection” must exist between the
state and the person, property, or transaction sought to be
taxed. 	See Allied-Signal, Inc. v. Dir., Div. of Taxation, 504
U.S. 768, 777 (1992) (internal quotations omitted). 	A deemed
asset sale of a Utah S corporation that does all of its business
within Utah provides a sufficient link or connection for Utah to
constitutionally assert taxing jurisdiction over a nonresident
shareholder of that corporation. 	As previously discussed, courts
have consistently affirmed the right of states to tax nonresident
shareholders of S corporations for business transactions
conducted within the taxing state. 	Moreover, it is inappropriate
to characterize the taxing authority of a state as equivalent to
the jurisdictional authority of the state. 	See J.C. Penney Co.,

15 	No. 20060521
311 U.S. at 445 (“We must be on guard against imprisoning the
taxing power of the states within formulas that are not compelled
by the Constitution but merely represent judicial generalizations
exceeding the concrete circumstances which they profess to
summarize.”). 	As the Supreme Court declared, “if [a state] has
jurisdiction of [a taxpayer’s] taxable property or transactions,
it may sometimes, through these, reach the nonresident.” 	Miller
Bros. Co. v. Maryland, 347 U.S. 340, 343 (1954).
¶44 	The Mandells also contend that Utah’s taxation of the
settlement proceeds violates the Commerce Clause and the
Privileges and Immunities Clause of the United States
Constitution. 	With respect to the Commerce Clause claim, the
United States Supreme Court has upheld the validity of state
taxing authority under the Commerce Clause if the tax “[1] is
applied to an activity with a substantial nexus with the taxing
State, [2] is fairly apportioned, [3] does not discriminate
against interstate commerce, and [4] is fairly related to the
services provided by the State.” 	Complete Auto Transit, Inc. v.
Brady, 430 U.S. 274, 279 (1977).
¶45 	We see no Commerce Clause violation in this case.
Because the settlement proceeds were paid in lieu of the proceeds
received from the deemed asset sale of HAU, there is “a
substantial nexus with the taxing state.” 	Moreover, the tax was
fairly apportioned, it did not discriminate against interstate
commerce, and it was fairly related to the services provided by
Utah because HAU was a Utah corporation doing business in Utah.
¶46 	We similarly reject the Mandells’ claim that Utah’s
taxation of the settlement proceeds violates the Privileges and
Immunities Clause. 	The Privileges and Immunities Clause protects
the “right of a citizen of any State to remove to and carry on
business in another without being subjected in property or person
to taxes more onerous than the citizens of the latter State are
subjected to.” 	Lunding v. N.Y. Tax Appeals Tribunal, 522 U.S.
287, 296 (1998) (internal quotations omitted). 	In this case,
however, the Commission imposed a tax on the Mandells’ settlement
proceeds because they were received in lieu of proceeds from the
taxable sale of Utah assets. 	The tax did not increase (or
decrease) when the Mandells became nonresidents. 	And this
analysis is not altered by the fact that Nevada does not impose
individual income taxes on its residents. 	Indeed, if Nevada did
levy individual income taxes, Utah would likely be required to
apportion some amount of the Utah source income to Nevada. 	See,
e.g., Utah Code Ann. § 59-10-118(2) (2006). 	Because the Mandells
are not being singled out due to their status as nonresidents,
there is no violation of the Privileges and Immunities Clause.

No. 20060521 	16
CONCLUSION
¶47 	We reject the Mandells’ claim that the settlement
proceeds were immune from taxation. 	We apply the “in lieu of”
test to determine the character and nature of the settlement
proceeds and conclude that they were received in lieu of proceeds
that Mandell should have received from the 1998 deemed asset sale
of HAU. 	As such, the settlement proceeds are taxable as Utah
source income. 	When the gains or losses of an S corporation pass
through to its shareholders, they retain their original
character. 	Thus, the Utah Tax Commission had authority to tax
the settlement proceeds. 	Affirmed.
---
¶48 	Chief Justice Durham, Associate Chief Justice Durrant,
Justice Wilkins, and Justice Nehring concur in Justice Parrish’s
opinion.