Did a nonresident owe Virginia tax on income passed through from a Virginia LLC and S corporation?

Subject

Virginia pass-through income required nonresident returns

Plain-English summary

Virginia required the State A resident to file 2003 and 2004 nonresident returns. He received income from a Virginia limited liability company and a Virginia S corporation but argued that he owed no Virginia tax because he was not a resident.

Virginia followed federal pass-through treatment. Partnership-classified LLC income kept the same source and character in the owner's hands, and Virginia-source S-corporation income likewise remained Virginia source for a nonresident shareholder.

Both entities operated in Virginia, and the LLC apportioned 100% of its income to Virginia. The owner's distributive shares were therefore taxable Virginia-source business income. He received 30 days to submit returns; otherwise the existing assessments would be deemed correct and collection would resume.

What this means for you

• Nonresidents can owe Virginia tax without becoming Virginia residents.
• Pass-through income generally keeps the entity-level source character.
• Virginia activity by an LLC or S corporation can create a nonresident filing duty for owners.
• Filing the requested returns could replace estimated assessments with return-based calculations.

Common questions

Why was the LLC income Virginia source?

The LLC operated in Virginia, apportioned 100% of its income there, and passed that character through to its owners.

Was the S corporation itself taxed?

Virginia generally did not tax the S corporation; it taxed the shareholder's pro rata share of Virginia-source income.

Citations and references

• Va. Code §§ 58.1-301, 58.1-302, 58.1-321, 58.1-325, 58.1-341, 58.1-391(B), and 58.1-401.
• IRC § 702(b).
• Treas. Reg. § 301.7701-1 et seq.
• P.D. 88-165 and 97-343.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-103

Original ruling text

June 24, 2009

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessments issued to * (the "Taxpayer") for the taxable years ended December 31, 2003 and 2004.

FACTS

The Taxpayer, a resident of * (State A), received income from a Virginia limited liability company (VALLC), and ** a Virginia S Corporation (VASC) for the taxable years at issue. Upon audit, the Department determined that the Taxpayer had Virginia source income and assessed additional tax. The Taxpayer contends he is not liable for Virginia income tax because he is not a Virginia resident.

DETERMINATION

Pursuant to Va. Code § 58.1-325, a nonresident individual who has income from carrying on a business, trade, profession, or occupation within Virginia is required to file a Virginia individual income tax return, unless the individual meets the filing exception described in Va. Code § 58.1-321. The Virginia taxable income of a nonresident is computed by multiplying his Virginia taxable income (computed as if he were a resident) by the ratio of his net income, gain, loss, and deductions from Virginia sources to his net income, gain, loss, and deduction from all sources. Under Va. Code § 58.1-302, "income and deductions from Virginia sources" includes income from "a business, trade, profession or occupation carried on in Virginia." Virginia Code § 58.1­341 requires every nonresident individual having Virginia taxable income to file an income tax return.

Limited Liability Company

In Public Document (P.D.) 97-343 (8/28/1997), the Department ruled that it would follow the federal election made by a limited liability company pursuant to the "check the box" regulations under Treas. Reg. § 301.7701-1 et seq . In fact, Virginia's conformity statute requires such a ruling because a limited liability company that is treated as a partnership or a disregarded entity for federal income tax purposes will have no federal taxable income as a starting point for computing its Virginia taxable income. See Va. Code § 58.1-301.

Virginia generally conforms to the federal treatment of partnerships. A partnership, as such, is not subject to income tax. Any income tax arising from the income of the partnership is the liability of the partners. Internal Revenue Code (IRC) § 702(b) states, "The character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share . . . shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership." Each item of pass-through entity income, gain, loss or deduction has the same character for an owner for Virginia income tax purposes as for federal income tax purposes. See Va. Code § 58.1-391 B. This would include a limited liability company that elects to be treated as a partnership for federal income tax purposes.

Subchapter S Corporation

Further, in following federal tax policy with respect to S corporations, Va. Code § 58.1-401 provides that such corporations are not subject to income tax in Virginia. Thus, Virginia has elected to treat S corporations in substantially the same manner as the Internal Revenue Service (IRS), i.e. , the corporate entity itself is not subject to taxation but the shareholders will be taxed as individuals on their pro rata share of S corporation income, to the extent includable in federal adjusted gross income (FAGI). See P. D. 88-165 (6/29/1988).

Virginia Code § 58.1-325 B provides statutory guidance for the treatment of a nonresident shareholder of an S corporation with Virginia activity. It has been the Department's longstanding policy that income received by an S corporation, which is determined to be income from Virginia sources, will remain Virginia source income in the hands of the shareholders.

The pass through entity returns and information obtained from the IRS indicate that both VALLC and VASC operated in Virginia and had Virginia source income. VALLC apportioned 100% of its income to Virginia. Because the owners of these entities elected to, have the income passed through to the individual owners, the Taxpayer is subject to tax on his distributive share of the income of VALLC and VASC.

CONCLUSION

Based on the foregoing, the Taxpayer is required to file Virginia nonresident income tax returns for the 2003 and 2004 taxable years. Such returns should be mailed to: Virginia Department of Taxation, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attn: *. The returns should be submitted within 30 days from the date of this letter. If the returns are not received within the time permitted, the 2003 and 2004 assessments will be deemed correct as issued, and collection action on the outstanding balance will resume.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2809439360.B