I live in another state and pay tax there on all my income, but I own a share of an S corporation that does business in Virginia -- do I still owe Virginia tax, and can I be penalized for not making Virginia estimated payments?

Plain-English summary

The IRS notified the Department that a taxpayer may have owed Virginia individual income tax for 2017. Because no Virginia return was on file, the Department requested more information; when it didn't get a response, it issued an assessment. The taxpayer appealed, arguing she was a resident of another state ("State A") and had already paid tax there on all her income. She separately contested a penalty assessed for underpaying her 2019 estimated tax.

Nonresidents with Virginia-source income must still file here. Virginia's income tax starts from federal adjusted gross income, and a nonresident (someone who is neither domiciled in nor an actual resident of Virginia) is still taxed on income from Virginia SOURCES -- specifically, income tied to Virginia real or tangible personal property, a trade/business/profession/occupation carried on in Virginia, or Virginia Lottery/gambling winnings. A nonresident with Virginia-source income exceeding the filing threshold must file a Virginia nonresident return, computing tax on a pro-rata share of income based on the ratio of Virginia-source income to total income.

S-corp income keeps its Virginia character. Here, the Department's records showed the taxpayer had an ownership interest in an S corporation that apportioned ALL of its income to Virginia for 2017. It's the Department's long-standing, consistently applied policy that once an S corporation's income is determined to be Virginia-source income at the entity level, it REMAINS Virginia-source income when it passes through to the shareholders -- regardless of where the shareholder personally lives. Since the amount involved exceeded Virginia's individual filing threshold, the taxpayer was required to file a Virginia nonresident return and pay Virginia tax on that income, even though she'd also reported (and presumably paid tax on) the same income in State A.

Estimated tax underpayment penalty upheld separately. Virginia also requires taxpayers to pay tax throughout the year via withholding or quarterly estimated payments; falling short triggers an "addition to tax" computed under a statutory formula. The Department's records showed the taxpayer hadn't made sufficient 2019 estimated payments, so when she filed her 2019 return and paid the remaining balance, the underpayment penalty was correctly assessed and remained due regardless of the 2017 residency dispute.

Next steps for the taxpayer. Since the Department had twice (in 2020 and 2021) asked for a 2017 Virginia nonresident return without receiving one, the Tax Commissioner gave the taxpayer one final 30-day window to file it; if she doesn't, the 2017 assessment will be finalized based on the information the Department already has, and collection will proceed. The 2019 estimated-tax penalty stands either way.

What this means for you

Nonresidents who own an interest in an S corporation with Virginia-apportioned income

Your share of that Virginia-apportioned income is Virginia-source income taxable to you as a nonresident, REGARDLESS of your personal residence and regardless of whether you also paid tax on the same income to your home state. Once that Virginia-source amount exceeds the filing threshold, you must file a Virginia nonresident return.

Nonresidents who receive a Department notice based on an IRS data match

Don't assume that paying tax in your home state resolves a Virginia filing obligation tied to Virginia-source income -- the two aren't mutually exclusive, and you generally still need to file the required Virginia nonresident return (any home-state credit issues are separate from whether Virginia return-filing is required).

Anyone contesting BOTH a residency-based assessment and a separate estimated-tax underpayment penalty

Expect the two issues to be decided independently -- winning (or losing) the residency argument doesn't automatically resolve an unrelated estimated-tax underpayment penalty tied to insufficient timely payments in a different tax year.

Common questions

Q: I don't live in Virginia, but I own a piece of an S corporation that does business here -- do I owe Virginia tax?
A: Potentially yes. If the S corporation's income is apportioned to Virginia, your distributive share of that income is Virginia-source income taxable to you as a nonresident, and once it exceeds the Virginia filing threshold you must file a nonresident Virginia return.

Q: I already paid tax on this same income to the state where I actually live -- doesn't that cover Virginia too?
A: Not according to this ruling -- Virginia taxes nonresidents on Virginia-source income regardless of where else that income was also reported and taxed; the Virginia filing obligation exists independently.

Q: Can I be assessed an estimated-tax underpayment penalty even while I'm disputing whether I owe Virginia tax at all for a different year?
A: Yes -- the two issues are evaluated separately. An underpayment-of-estimated-tax penalty tied to insufficient timely payments in one tax year isn't excused by a residency dispute over a different tax year.

Citations and references

• Va. Code § 58.1-325 -- provides statutory guidance for the treatment of a nonresident shareholder of an S corporation with Virginia activity
• Va. Code § 58.1-302 -- defines "income and deductions from Virginia sources" for nonresident taxation purposes
• Va. Code § 58.1-492 -- governs the addition to tax (underpayment of estimated tax penalty), computed under a statutory formula

Subject

Residency : Nonresident - Income from VA Sources; Administrative : Estimated Tax - Addition to Tax (Underpayment Penalty)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-98

Original ruling text

July 27, 2021

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 “Taxpayer”) for the taxable years ended December 31, 2017, and 2019.

FACTS

The Department received information from the Internal Revenue Service (IRS) indicating that the Taxpayer may have been required to file a Virginia individual income tax return for the 2017 taxable year. Because no return was on file, the Department requested additional information in order to determine if her income was taxable in Virginia. When a response was not received, the Department issued an assessment. The Taxpayer appeals, contending she was a resident of * (State A) and paid tax on all her income in State A. In addition, the Taxpayer contests the penalty for the underpayment of estimated tax assessed for the 2019 taxable year.

DETERMINATION

Nonresident Income

Virginia Code § 58.1-301 provides, with certain exceptions, that the terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income (VTI) with federal adjusted gross income (FAGI). Income properly included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia .

Individuals who are neither domiciliary nor actual residents of Virginia and have income from Virginia sources are taxed as nonresidents, unless the individual meets the filing exception described in Virginia Code § 58.1-321. See Virginia Code § 58.1-325. The Virginia taxable income of a nonresident is computed by multiplying her Virginia taxable income (computed as if she were a resident) by the ratio of her net income, gain, loss, and deductions from Virginia sources to her net income, gain, loss, and deductions from all sources. Virginia Code § 58.1-302 limits the term income and deductions from Virginia sources to the items of income, gain, loss, and deductions attributable to (1) the ownership of any interest in real or tangible personal property in Virginia, (2) a business, trade, profession or occupation carried on in Virginia, or (3) prizes paid by the Virginia Lottery Department, and gambling winnings from wagers placed or paid at a location in Virginia. Thus, a nonresident with Virginia source income is required to file a nonresident Virginia income tax return unless the filing exemption applies. See Virginia Code § 58.1-341 A 2.

The Department’s records indicate that the Taxpayer received income from an ownership interest in an S corporation that apportioned all of its income to Virginia for the 2017 taxable year. As such, this income was from Virginia sources. 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. In addition, the amount of income in question exceeded the filing threshold set forth in Virginia Code § 58.1-321. The Taxpayer, therefore, was required to file a Virginia nonresident income tax return.

Underpayment of Estimated Tax Penalty

Virginia Code § 58.1-492 provides for an “addition to tax” (commonly called the estimated tax underpayment penalty) in the event of an underpayment of estimated tax. Under current law, taxpayers are required to make timely income tax payments throughout the year by having tax withheld from wages or making estimated payments. Taxpayers who do not have enough tax withheld from their income must make four estimated tax payments throughout the taxable year. The penalty is computed by applying a detailed formula set forth in Virginia Code § 58.1-492. The Department’s records indicate that the Taxpayer did not make sufficient estimated tax payments during the 2019 taxable year to avoid imposition of the penalty under the statutory formula. Accordingly, when she filed her 2019 Virginia return and paid the balance of tax due, the estimated tax underpayment penalty was assessed.

CONCLUSION

Although it appears that the Taxpayer was not a resident of Virginia during the 2017 taxable year, she had sufficient income from Virginia sources to require the filing of a nonresident Virginia income tax return and payment of the tax due on such income. Although the Taxpayer may have reported this income on her 2017 State A return, she was still liable for Virginia income tax on any income from Virginia sources. The Department requested that the Taxpayer file a 2017 Virginia nonresident return in its letters dated May 1, 2020, and March 1, 2021. To date, no return has been filed.

The Taxpayer, however, will be given one final opportunity to file a nonresident Virginia income tax return for the 2017 taxable year. The return should be submitted within 30 days from the date of this letter to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond Virginia 23161-7203, Attention: *. Upon receipt, the return will be reviewed and the assessment will be adjusted, as appropriate. If the return is not received within the allotted time, the assessment will be adjusted based on the information available and collection actions will resume. In addition, the penalty for the underpayment of estimated tax issued for the 2019 taxable year remains due and payable.

The Code of Virginia sections 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

AR/3636.B