My partnership owns rental properties in Virginia and three other states, and I can calculate each property's actual income separately -- can I use that separate accounting instead of Virginia's standard apportionment formula?

Plain-English summary

A family limited partnership owned one rental property in Virginia and three similar rental properties in other states. Because the partnership could readily determine the actual income or loss generated by each individual property, it believed Virginia's standard apportionment method didn't accurately reflect its true Virginia-source income, and it asked the Department for permission to instead use SEPARATE ACCOUNTING -- allocating Virginia income based on that specific property's own actual results -- starting with the 2014 taxable year.

Pass-through entities apportion just like corporations. When a partnership's entire business isn't conducted solely within Virginia, its Virginia-source income is determined by allocating and apportioning income the same way corporations do, under Virginia's standard multi-factor apportionment statutes.

Two independent reasons for denial. First, the taxpayer skipped the required procedure: to request an alternative apportionment method, a taxpayer must first file its return using the STANDARD statutory method and pay any tax due, then file a timely amended return (within the refund-claim deadline) proposing the alternative method with a full explanation of why the standard method is inapplicable or inequitable. This partnership instead sought approval directly through a ruling request, without ever giving the Department the chance to examine actual filed returns and underlying records.

Knowing your separate numbers isn't the same as proving inequity. Second, and more fundamentally, the fact that separate accounting produces a DIFFERENT result than the statutory apportionment formula isn't, by itself, evidence that the statutory method is inequitable -- Virginia's regulation requires showing the standard method causes actual double taxation attributable specifically to Virginia's own scheme (not just a different, and arguably more "accurate," alternative number). The Department has specifically applied this standard before to taxpayers in the business of renting real estate, and reached the same conclusion here: without evidence the statutory formula produces an unconstitutional or grossly distorted result -- not just a different one -- the request must be denied.

What this means for you

Multi-state pass-through entities (partnerships, LLCs) with rental or other multi-property operations

Being able to calculate each property's or location's own separate income doesn't, by itself, justify bypassing Virginia's standard apportionment formula -- you still need to show the statutory method causes genuine double taxation attributable to Virginia, not just a numerically different result under separate accounting.

Anyone considering requesting an alternative apportionment method for a partnership or other pass-through entity

Follow the required two-step procedure: file using the standard statutory method and pay any tax due, THEN file a timely amended return proposing the alternative, with a full explanation of the inequity. Requesting pre-approval directly, without underlying filed returns, is unlikely to succeed.

Real estate rental businesses operating in Virginia and other states

This ruling confirms the Department has specifically and repeatedly applied its general apportionment-alternative-method standards to real estate rental businesses -- don't expect special treatment just because your business model makes separate accounting for each property administratively easy.

Common questions

Q: My partnership can easily calculate each rental property's own separate income -- doesn't that automatically justify using separate accounting for Virginia tax purposes?
A: No -- being ABLE to calculate separate figures, and those figures producing a different result than the statutory formula, isn't enough by itself. You must show the statutory apportionment method causes genuine inequity (typically double taxation attributable to Virginia), not merely a numerical difference.

Q: What's the correct way to request an alternative apportionment method in Virginia?
A: File your return first using the standard statutory method and pay any tax due, then file a timely amended return (within the refund-claim deadline) proposing the alternative method, explaining specifically why the standard method is inapplicable or inequitable.

Q: Has the Department addressed this kind of request from a real estate rental business before?
A: Yes -- the Department has previously applied these same apportionment-alternative-method standards to taxpayers in the business of renting real estate, reaching the same result.

Citations and references

• Public Document 07-150 (9/21/2007) -- pass-through entities not wholly conducting business within Virginia apportion income the same way corporations do
• Moorman Mfg. Co. v. Bair, 437 U.S. 267 (1978) (apportionment is an inherently approximate process; a state's method is constitutionally valid if rationally related to business transacted within the state)
• Hans Rees' Sons, Inc. v. North Carolina, 283 U.S. 123, 135 (1931), and Norfolk & Western R. Co. v. Missouri State Tax Commission, 390 U.S. 317, 326 (1968) (an apportionment formula is only disturbed with clear and cogent evidence of an out-of-proportion or grossly distorted result)
• Corp. Exec. Bd. Co. v. Va. Dep't of Taxation, 297 Va. 57, 822 S.E.2d 918 (2019) (Virginia's apportionment method doesn't violate Due Process/Commerce Clauses merely because of overlap with another state's tax; double taxation alone isn't unconstitutional)
• Department of Taxation v. Lucky Stores, Inc., 217 Va. 121, 225 S.E.2d 870 (1976), and Public Documents 85-61, 86-88, 92-85, 06-13, 07-75, 11-138, and 13-86 (the Department disfavors separate accounting; a different result under separate accounting alone doesn't show the statutory method is inequitable)
• Public Document 99-195 (7/21/1999) and P.D. 09-47 (4/27/2009) -- the Department has previously addressed this same alternative-apportionment issue specifically for taxpayers in the business of renting real estate

Subject

Pass-through Entity (PTE) : Apportionment - Alternative Method

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-100

Original ruling text

July 27, 2021

Re: Ruling Request: Allocation and Apportionment of Income

Dear *:

This will respond to your request that * (the “Taxpayer”) be permitted to use an alternative method of apportionment for Virginia income tax purposes.

FACTS

The Taxpayer, a family limited partnership, owns a rental property in Virginia and three similar properties in other states. The Taxpayer states the income or loss of each rental property is readily available. The Taxpayer believes that Virginia’s apportionment method does not accurately reflect income earned in Virginia and requests permission to allocate income to Virginia based on separate accounting for the 2014 taxable year and thereafter.

RULING

If the entire business of the pass-through entity is not deemed to have been transacted or conducted within Virginia, then such pass-through entity's income from Virginia sources is the portion of income allocated and apportioned to Virginia in the same manner as corporations. See Public Document (P.D.) 07-150 (9/21/2007). Accordingly, partnerships that have income that is subject to tax in Virginia and at least one other state are required to apportion income as provided in Virginia Code §§ 58.1-408 through 58.1-421

The United States Supreme Court has recognized that allocation and apportionment of income is an arbitrary process designed to approximate income from business transactions within a state. As long as each state’s method of allocation and apportionment is rationally related to the business transacted within a state, then each state's tax is constitutionally valid even though there may be some overlap. See Moorman Mfg. Co. v. Bair , 437 U.S. 267, 98 S. Ct. 2340 (1978). Thus, the Taxpayer must show that the statutory method of apportionment produces an unconstitutional result.

An apportionment formula used as an approximation of an entity’s income reasonably related to the activities conducted within a taxing state will only be disturbed when the taxpayer has proved by “clear and cogent evidence” that the income attributed to the state is in fact “out of all reasonable proportion to the business transacted . . . in that state,” Hans Rees' Sons, Inc. v. North Carolina , 283 U.S. 123, 135 (1931), or has “led to a grossly distorted result,” Norfolk & Western R. Co. v. Missouri State Tax Commission , 390 U.S. 317, 326 (1968).

Recently, the Virginia Supreme Court’s decision in Corp. Exec. Bd. Co. v. Va. Dep't of Taxation , 297 Va. 57, 822 S.E.2d 918 (2019) found that Virginia’s apportionment method did not violate the Due Process or Commerce clauses of the United States Constitution or Virginia Code § 58.1-421 and did not create a distorted result because the tax imposed on services rested upon the labor of employees in Virginia. Recognizing the United States Supreme Court’s decision in Moorman Mfg. , 437 U.S. at 274, Virginia’s highest court acknowledged that the existence of double taxation does not, by itself, violate the United States Constitution. Further, it conceded the inevitability of states devising different schemes of taxation and apportionment. Corp. Exec. Bd ., 297 Va. at 72, 822 S.E.2d at 925 Thus, states are granted wide latitude in adopting apportionment formulas. See Moorman Mfg ., 437 U.S. at 274.

Title 23 of the Virginia Administrative Code (VAC) 10-120-280 goes even further by permitting taxpayers an alternative method when the statutory method of allocation and apportionment is inequitable. Under the standards of the regulation, a statutory method can be found to be inequitable if: (1) it results in double taxation of the income, or a class of income, of the taxpayer; and (2) the inequity is attributable to Virginia, rather than to the fact that some other state has a unique method of allocation and apportionment.

The Department’s long-standing policy holds the use of separate accounting in disfavor. See Department of Taxation v. Lucky Stores, Inc., 217 Va. 121, 225 S.E.2d 870 (1976), P.D. 85-61 (3/18/1985), P.D. 86-88 (4/30/1986), P.D. 92-85 (6/1/1992), P.D. 06-13 (2/7/2006), P.D. 07-75 (5/18/2007), P.D. 11-138 (7/28/2011) and P.D. 13-86 (6/10/2013). The fact that separate accounting produces a different result from the statutory method is not sufficient to show the statutory apportionment method is inequitable. The Taxpayer has provided no evidence to demonstrate the statutory apportionment method is inequitable. Further, the Department has previously addressed this issue with regard to taxpayers engaged in the business of renting real estate in P.D. 99-195 (7/21/1999) and P.D. 09-47 (4/27/2009).

In addition, the Taxpayer has not followed the established procedure for requesting an alternative apportionment method. The policies that apply to requests for an alternative method of allocation and apportionment under Virginia Code § 58.1-421 are well established. In order for a taxpayer to request an alternative method of allocation and apportionment, the taxpayer must file the return using the statutory method and pay any tax due. Next, the taxpayer is required to file an amended return proposing an alternative method within the time prescribed for filing amended returns claiming refunds. The amended return must include a statement of why the statutory method is inapplicable or inequitable and an explanation of the proposed method of allocation and apportionment. The Department will not grant an alternative method of allocation and apportionment unless it determines: (1) the statutory method produces an unconstitutional result under the particular facts and circumstances of the taxpayer's situation; or 2) the statutory method is inequitable because it results in double taxation and the inequity is attributable to Virginia, rather than another state's method of apportionment. See Title 23 VAC 10-120-280.

In the context of a ruling request, when a taxpayer does not provide the Department with the opportunity to examine the records underlying the claim, the taxpayer cannot demonstrate that Virginia’s factor formula produces an unreasonable or distorted result. Further, because constitutional apportionment is designed to approximate income from business transactions within a state and not result in actual income from business transactions within a state, a taxpayer's argument that Virginia’s statutory method does not accurately reflect income in Virginia cannot be accepted.

The use of an alternative method is allowed only in extraordinary circumstances where the need for relief has been demonstrated by clear and cogent evidence. Based on the facts presented, the Taxpayer has not demonstrated that the statutory method is unconstitutional or inapplicable as it would apply to the Taxpayer’s business. Furthermore, the Taxpayer’s request is not in accordance with the procedure for requesting an alternative method of allocation and apportionment outlined in Title 23 VAC 10-120-¬280. Based on the foregoing, I must deny the Taxpayer’s request to use an alternative method of allocating and apportioning income.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/577o

Related Documents

07-150

85-61

86-88

92-85

06-13

07-75

11-138

13-86

09-47

99-195