Did nonresident partners have Virginia-source income from a Virginia limited partnership, and could prior losses offset the 2005 income?

Subject

Assessment on unstated income from Virginia sources.

Plain-English summary

Nonresident spouses owed Virginia tax on the husband's share of income from a limited partnership that held assets and conducted business in Virginia. The partnership liquidated in 2005 and reported interest, a net operating loss, and a substantial gain from selling its assets. Its Virginia return apportioned part of those items to Virginia.

Partnership income keeps its source and character when it passes through to a partner. The husband did not personally need to operate a Virginia business or directly own Virginia property for his share of the partnership's Virginia-apportioned items to qualify as Virginia-source income.

The spouses argued that partnership losses from earlier years should reduce the 2005 income. Virginia permits net operating, capital, and passive-activity loss carryforwards only to the extent they are allowed in computing federal taxable income. If the earlier losses were not carried forward into 2005 federally, they could not be carried forward for Virginia purposes.

Virginia also reasoned that the losses had already reduced tax in the spouses' home state in prior years, so allowing another 2005 offset would give them a double benefit. The assessment was upheld.

What this means for you

• A nonresident partner can have Virginia-source income through a partnership doing business or holding assets in Virginia.
• Pass-through items generally retain their character and source in the partner's hands.
• Virginia loss carryforwards depend on corresponding federal treatment.
• Direct personal ownership of Virginia property is not required when the income passes through from a Virginia-operating partnership.

Common questions

Why was the partnership distribution Virginia-source income?

The partnership held assets and conducted business in Virginia, and it apportioned part of its income and loss to Virginia.

Could earlier partnership losses offset the 2005 gain?

Only if those losses were carried forward to 2005 for federal income tax purposes; the ruling found no allowable Virginia offset on the evidence presented.

What happened to the assessment?

Virginia upheld it and said a revised bill with interest would be mailed.

Citations and references

• Va. Code §§ 58.1-302, 58.1-325, and 58.1-391(B).
• IRC § 702(b).
• Virginia Public Documents 92-133, 96-256, and 03-66.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-168

Original ruling text

August 10, 2010

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 assessment issued to * (the "Taxpayers"), for the taxable year ended December 31, 2005. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayers, a husband and a wife, are domiciliary residents of * (State A). The husband held an interest in *** (LP), a State A limited partnership that conducted business both within and without Virginia. During 2005, LP was liquidated. In addition to a net operating loss and interest income, LP reported a substantial gain from the sale of its assets. On its 2005 pass-through entity return, LP appropriately apportioned income and losses to Virginia.

The Taxpayers filed a Virginia nonresident individual income tax return after being contacted by the Department. Under review, the Department found that the Taxpayers had unstated income from Virginia sources and issued an assessment. The Taxpayers appeal the assessment, contending the Department's computation fails to account for losses occurring in previous years. In addition, the Taxpayers assert that Virginia lacks jurisdiction to impose income tax because they did not conduct business or own property in Virginia.

DETERMINATION

Loss Carryrforwards

Individuals who are neither domiciliary nor actual residents of Virginia and have income from Virginia sources are taxed as nonresidents. The Virginia taxable income of a nonresident is defined under Va. Code § 58.1-325 as "an amount bearing the same proportion to his Virginia taxable income, computed as though he were a resident, as the net amount of his income, gain, loss and deductions from Virginia sources bears to the net amount of his income, gain, loss and deductions from all sources."

In general, Virginia income tax laws do not address net operating losses. Nonetheless, Va. Code § 58.1-3011 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code, unless a different meaning is clearly required. Because the starting point in computing Virginia taxable income is federal taxable income; Virginia allows a net operating loss deduction (NOLD) to the extent that it is allowable in computing federal taxable income. The treatment would be the same for capital losses and passive activity losses. As such, no loss can be carried forward to any year without a corresponding carryforward for federal purposes. See Public Document (P.D.) 92-133 (8/4/1992), P.D. 96­-256 (9/30/1996) and P.D. 03-66 (8/14/2003).

Therefore, if the Taxpayers' losses for previous taxable years were not carried forward to the 2005 taxable year for federal income tax purposes, no loss can be carried forward to 2005 for Virginia income tax purposes.

A review of the individual income tax laws of the Taxpayers' state of residence indicates a system similar to Virginia. The Taxpayers should have paid less income tax to State A in prior taxable years than they would have if they had not received the losses from LP's business conducted in Virginia. Thus, the Taxpayers' have not lost the tax benefits of the losses passed through from LP. Allowing the prior losses to offset income in 2005 essentially allows a double benefit: for the losses. Consequently, LP's prior losses cannot be used in determining the amount of the Taxpayers' Virginia taxable that was apportioned to Virginia for the 2005 taxable year.

Income from Virginia Sources

Virginia Code § 58.1-302 defines income and deductions from Virginia sources to include items of income, gain, loss and deduction attributable to: (1) the ownership of any interest in real or tangible personal property in Virginia; and (2) a business, trade, profession or occupation carried on in Virginia.

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 § 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 partnership.

In the case at hand, LP was a limited partnership operating in Virginia. LP distributed income to the husband for the 2005 taxable year. The distribution from LP consisted primarily of net rental real estate loss, interest and a net gain on the sale of assets. Because LP held assets and conducted business in Virginia, its Virginian pass­through entity return apportioned some of the income and loss to Virginia. Such income and loss clearly represent income from Virginia sources.

Based on the evidence provided, the assessment is upheld. A revised bill, with interest accrued to date, will be mailed shortly to the Taxpayers. No additional interest will accrue provided the outstanding assessment is paid within 30 days from the date of the revised bill.

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,

Linda Foster

Deputy Tax Commissioner

AR/1-3834674376.E