Must a Virginia pass-through entity withhold for a nonresident owner whose other-state tax credit eliminates the Virginia liability?

Subject

Other-state credit could eliminate pass-through withholding for a nonresident owner

Plain-English summary

Virginia allowed the partnership not to withhold for a nonresident owner whose other-state tax credit fully offset the Virginia tax attributable to that owner's pass-through share. The exception was individual, not automatic for every owner who could claim some credit.

The ruling said the credit was sufficient only when it exceeded the taxpayer's entire Virginia income-tax liability. It then identified Arizona, California, the District of Columbia, and Oregon as the four resident jurisdictions eligible for the credit under the rules then in effect, while explaining that differing tax rates meant the result still could vary by owner.

What this means for you

• Do not assume that eligibility for an other-state credit creates a blanket withholding exception.
• Determine whether the particular owner's allowable credit fully offsets the Virginia tax tied to the distributed share.
• The four-jurisdiction and rate discussion reflects 2009 law and instructions, not necessarily current rules.
• Other statutory and return-based exceptions may also apply.

Citations and references

• Va. Code § 58.1-486.2(A).
• 2007 Va. Acts ch. 796 (Senate Bill 1238).
• P.D. 07-150, Guidelines for Pass-Through Entity Withholding.
• 2008 Virginia Form 502 instructions.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 09-59

Original ruling text

May 1, 2009

Re: Ruling Request: Pass-Through Entity Withholding

Dear *:

This is in response to your letter on October 21, 2008, in which you requested a ruling regarding the pass-through entity withholding tax.

FACTS

You represent the * ("the Partnership"), which has both Virginia source income and *** source income earned from pass-through entities engaged in residential and commercial real estate rental activities. The Partnership annually files Virginia Form 502, Pass-Through Entity Return of Income and Return of Nonresident Withholding Tax, and reports the Virginia source income. All of the Partnership's limited partners are nonresident individuals or nonresident fiduciaries.

Several of the limited partners are residents of California and the District of Colombia. These partners claim a credit on Virginia Form 763, Nonresident Income Tax Return, for taxes paid to their respective states of residence. You state that this credit has historically been equal to the Virginia tax liability.

In light of the fact that these nonresident limited partners are not required to pay any tax to Virginia, you ask whether the pass-through entity withholding tax is required to be paid on behalf of a taxpayer whose credit for taxes paid to other states is sufficient to offset all Virginia income tax attributable to the shares of income distributed by a pass-through entity.

DETERMINATION

During the 2007 General Assembly Session, Senate Bill 1238 (Chapter 796, 2007 Acts of Assembly) was enacted. This legislation created a new tax to be imposed on pass-through entities. This tax is not applicable to all pass-through entities, however. Instead, under Va. Code , § 58.1-486.2 A, "a pass-through entity that has taxable income for the taxable year derived from or connected with Virginia sources, any portion of which is allocable to a nonresident owner" must pay the tax. The tax is equal to five percent of the nonresident owners' shares of income from Virginia sources. The pass-through entity may apply any tax credits allowable under the Code of Virginia that flow through to nonresident owners.

Pass-through entities are not always required to pay the withholding tax and they may not be required to withhold for every nonresident member. The law provides for certain exceptions, which are more fully described in Public Document ("P.D.") 07-150, "Guidelines for Pass-Through Entity Withholding." Further, the Form 502 Instructions for 2008 offer further explanation of these exceptions.

The instructions state that no withholding of Virginia income tax is required on behalf of the following nonresident owners: (1) individuals who are exempt from paying federal income taxes, who are exempt from Virginia income taxes, or whose credit for taxes paid to other states is sufficient to offset all Virginia income tax attributable to the shares of income distributed by the PTE; (2) individuals included on a unified return (Form 765); (3) entities other than individuals and corporations that are exempt from federal income taxes; and (4) corporations exempt from Virginia income tax.

Exception 1 includes taxpayers whose credit for taxes paid to other states is sufficient to offset all Virginia income tax attributable to the shares of income distributed by the pass-through entity. A credit for taxes paid to other states will be considered sufficient if the credit is greater than the taxpayer's entire Virginia income tax liability. Currently, nonresidents from only four states are eligible for this credit. These states are: Arizona, California, the District of Colombia and Oregon.

The credit for taxes paid to the District of Colombia and Oregon will generally be sufficient to cover the full Virginia liability because their current tax rates are higher than Virginia's current tax rate. A credit from Arizona will generally not be sufficient to cover the full Virginia liability because the current tax rate is lower than Virginia's current tax rate. Lastly, a credit from California will sometimes be sufficient because California currently has tax rates that are higher and lower than Virginia's current tax rate, depending on the amount of taxable income.

Therefore, the Department of Taxation ("TAX") cannot allow a blanket exception for the pass-through entity withholding tax requirement for every nonresident who can claim a credit for taxes paid to another state. We will, however, offer an exception for those taxpayers that will have a credit for taxes paid to other states that is sufficient to offset all Virginia income tax attributable to the shares of income distributed by the pass-through entity. Based upon the facts that you have presented, no withholding will be required for those limited partners of the Partnership whose credit is sufficient to offset their Virginia tax liability.

The referenced documents are available on TAX's website located at www.tax.virginia.gov. I hope the foregoing has responded to your inquiry and should you have additional questions, please contact * in the Office of Tax Policy and Administration, Policy Development Division, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

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