Could Virginia abate pass-through withholding assessments when the LLC had paid enough tax into the wrong employer-withholding account?

Subject

Employer withholding payments covered pass-through withholding

Plain-English summary

Virginia abated the LLC's pass-through withholding assessments because it had already paid enough tax into its employer-withholding account. The out-of-state LLC had calculated nonresident-owner withholding and reported it on its pass-through returns for 2008 through 2011, but remitted the money under the wrong account and forms.

The Department distinguished the two systems. Employer withholding applied to employee wages, while partners generally were not employees and received Schedule K-1 rather than Form W-2. Pass-through entities with Virginia-source income allocated to nonresident owners had to compute and remit the separate owner withholding described in the ruling.

Because the account review showed sufficient employer-withholding payments, the Department abated the assessments. It also directed a refund of the January through December 2011 overpayment with appropriate interest.

For future periods, the LLC had to report pass-through income and withholding on Form 502 and remit it on Form 502W, rather than combining it with employee withholding or reporting it on W-2s.

What this means for you

• Reconcile payment accounts as well as filed returns; money paid under the wrong tax type may not automatically satisfy the correct account.
• Do not treat partners or members as employees merely to use payroll-withholding forms.
• Nonresident owners generally claim credit for proper pass-through withholding on their Virginia nonresident returns.

Common questions

Q: Did Virginia forgive unpaid tax?
A: No. The Department found that enough tax had actually been remitted through the employer account.

Q: Could the LLC keep using the employer account?
A: No. The ruling instructed it to use Forms 502 and 502W for pass-through withholding.

Q: Was a refund due?
A: Yes. The 2011 overpayment was to be refunded with appropriate interest.

Citations and references

• Va. Code §§ 58.1-390.2, 58.1-460, 58.1-461, 58.1-486.1, and 58.1-486.2.
• IRC § 3401(a).
• Public Documents 07-148 and 07-150.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-39

Original ruling text

March 19, 2014

Re: § 58.1-1821 Application: Withholding Tax

Dear *:

This will respond to your letter submitted on behalf of your client, * (the "Taxpayer"), in which you seek correction of the pass-through entity withholding tax assessment issued for the taxable periods January 2008 through December 2011. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer, an out-of-state pass-through entity, is a limited liability company that is treated as a partnership for federal income tax purposes. For the taxable periods at issue, the Taxpayer computed withholding tax based on the nonresident owner's share of income from Virginia sources. Virginia pass-through entity income tax returns were filed for the 2008 through 2011 periods reporting the amount withheld. Because no pass-through entity withholding tax was remitted, however, the Taxpayer was assessed for the tax plus interest. The Taxpayer appeals the assessments, contending that all pass-through entity withholding tax due was reported and paid under the Taxpayer's employer withholding account.

DETERMINATION

Employer Withholding

Virginia Code § 58.1-461 requires employers to withhold taxes from employee wages for each payroll period. Virginia Code § 58.1-460 defines "employer" as "[t]he person, whether a resident or nonresident of the Commonwealth , for whom an individual performs or performed any service as an employee ...." [Emphasis added].

Further, this section defines "employee" as "[a]n individual, whether a resident or a nonresident of the Commonwealth , who performs or performed any service in the Commonwealth for wages ...." [Emphasis added]. Under Va. Code § 58.1-460, wages are the same as defined under Internal Revenue Code (IRC) § 3401(a). Thus, wages consist of all remuneration (other than fees paid to a public official) for services performed by an employee for his employer. As such, an employer located outside of Virginia may be required to withhold Virginia income taxes for an employee who is not a resident of Virginia when that employee earns income from Virginia sources.

The Taxpayer reported and paid its pass-through entity withholding on employer withholding forms. Partners are not generally considered to be employees and are not issued a Form W-2. Instead, a partnership will furnish a Schedule K-1 to its partners. The partners then report their distributive share of any item or class of items of income, gain, loss, deduction, or credit of the partnership on their individual income tax return. As such, pass-through entities should not use Virginia employer withholding forms for reporting pass-through entity withholding.

Pass-Through Entity Withholding

Virginia Code § 58.1-486.2 A provides that "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 withholding tax. The amount of tax that must be withheld is equal to 5% of the nonresident owner’s share of income from Virginia sources of all nonresident owners that may lawfully be taxed by Virginia and which is allocable to a nonresident owner. See Va. Code § 58.1-486.2 B 1. Under Va. Code § 58.1-486.1, a "nonresident owner" is any person treated as a partner, member, or shareholder of the pass-through entity for federal income tax purposes and, in the case of an individual, is not a domiciliary or actual resident of Virginia.

Pursuant to Va. Code § 58.1-390.2, owners of pass-through entities are liable for tax "only in their separate or individual capacities on income passed through to the owners of pass-though entities ". [Emphasis added.] As such, owners are subject to tax on their distributive share of items of income, gain, loss, deduction, or credit of the partnership. Therefore, when nonresidents are owners of pass-through entities, the pass-through entity must compute, report and remit withholding tax. See Va. Code § 58.1-486.2 A and the Guidelines for Pass-Through Entity Withholding , issued as Public Document (P.D.) 07-150 (9/21/2007).

Pass-through entities that have taxable income from Virginia sources and that must allocate any portion of that income to at least one nonresident owner during any portion of the taxable year must pay the withholding tax unless an exemption applies. See P.D. 07-150.

Generally, pass-through entities must remit the required withholding tax with the Pass-Through Entity Return of Income and Return of Nonresident Withholding (Form 502). In such cases, the pass-through entity withholding must be remitted by the 15th day of the fourth month following the close of the taxable year on the Pass-Through Entity Withholding Tax Payment form (Form 502W).

Nonresident owners

Nonresident owners are required to file a Virginia Nonresident Income Tax Return (Form 763) to report their income from Virginia sources, unless certain exceptions apply or Virginia adjusted gross income from all sources does not exceed the filing threshold. See P.D. 07-148 (9/12/2007). When nonresident owners file their nonresident Virginia return, they will receive a credit for the amount of income tax that was withheld by the pass-through entity. The nonresident owner is then liable for any income tax liability in excess of the credit. Any overpayment of tax would be refunded.

CONCLUSION

A review of the Taxpayer's accounts indicate sufficient employer withholding was remitted to the cover the pass-through entity withholding for the 2008 through 2011 taxable periods. As such, the assessments for the taxable periods at issue have been abated. A refund of the overpayment for the January 2011 through December 2011 taxable period will be issued, along with the appropriate interest.

The Taxpayer is hereby notified that its pass-through entity withholding should not be remitted with employer withholding for other employees and reported on a W-2 form. The Taxpayer should instead withhold Virginia income tax from the pass-through entity's income and report and remit such withholding with the Form 502 on a Form 502W.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions 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,

Craig M. Burns

Tax Commissioner

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