Tax Type
Individual Income Tax
Description
Taxpayer s must file amended returns within 30 days
Topic
Domicile
Date Issued
09-12-2007
September 12, 2007
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the Virginia individual income tax assessments issued to ***** (the "Taxpayers") for the taxable years ended December 31, 2003 through 2005. I apologize for the delay in responding to your letter.
FACTS
The Taxpayers, a husband and wife, were Virginia residents who moved to ***** (State A) and established domicile there in 2002. The Taxpayers filed Virginia part-year resident income tax returns for the 2003 through 2005 taxable years. During this time, the husband owned several pass-through entities. The accounting for these businesses was done by the Taxpayer's certified public accountant in Virginia. For the taxable years at issue, the accountant apportioned all the income of these businesses to Virginia. None of this pass-through income, however, was reported as Virginia source income on the Taxpayers' Virginia part-year resident income tax returns.
Under audit, the Department made an adjustment to include all the income of ***** (ASC), an S corporation, as Virginia source income and issued assessments. The Taxpayers contest the assessments, asserting that ASC operated solely in State A and had no Virginia source income.
DETERMINATION
During the process of reviewing this case, the Department identified numerous errors on the tax returns in addition to the audit adjustments, each of which are addressed separately below.
ASC
ASC is an insurance broker. Based on ASC's Virginia returns, it was located in Virginia and 100% of its income was apportioned to Virginia resulting in assessments against the Taxpayers issued by the Department.
The Taxpayers assert that the Virginia address used on ASC's returns was the location of its bookkeeper and accountant, and the accountant mistakenly apportioned all of the income to Virginia. According to the Taxpayers, all of ASC's business activities were conducted in State A, and ASC had no nexus with Virginia.
Public Law (P.L.) 86-272, codified at 15 U.S.C. § 381-384, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sales of tangible personal property. The Department's policy is to extend the "solicitation test" of P.L. 86-272 to situations involving the sale of services. See Public Document (P.D.) 93-75 (3/17/1993). The Department, however, limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr. Co., 505 U.S. 214 (1992).
During the taxable years at issue, the Taxpayers resided in State A for more than half of each year, but spent more than 5 months in Virginia. Although ASC did not conduct a large number of transactions, they appear to be complex in nature involving a protracted time to complete. Consequently, it appears likely that the husband conducted some operations of ASC while he was in Virginia.
Further, ASC owned an automobile that was registered in Virginia. The Taxpayers assert that the vehicle should not be included in the property factor at all. ASC, however, claimed a Section 179 deduction for the vehicle on its federal income tax return. Although no information has been provided as to the exact location of the vehicle during the period at issue, it appears that the Taxpayers used the vehicle in Virginia. Because the vehicle was available for use by the husband to conduct the business of ASC, and such activities went beyond the mere solicitation of sales, ASC is considered to have property in Virginia for the conduct of activities that were not de minimus in nature.
Accordingly, ASC had nexus with Virginia for the 2004 and 2005 taxable years and must apportion its income using Virginia's standard three-factor formula. The automobile must be included in the numerator of the property factor to the extent it was in Virginia, based on mileage or days. See Title 23 of the Virginia Administrative Code (VAC) 10-120-170 D. For payroll factor purposes, the husband's salary from ASC would likely be attributed to State A. See Title 23 VAC 10-120-200. Because ASC is in the business of selling other than tangible personal property, its receipts would be attributed based on where the income producing activity for each transaction is performed. See Title 23 VAC 10-120-230.
Nonresidents
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."
Pursuant to Va. Code § 58.1-341, a nonresident individual who has income from carrying on a business, trade, profession, or occupation within Virginia is required to file a Virginia Nonresident Individual Income Tax Return, currently Form 763, unless the individual meets the filing exception described in Va. Code § 58.1-321. The Virginia taxable income of a nonresident is computed by multiplying his Virginia taxable income (computed as if he were a resident) by the ratio of his net income, gain, loss, and deductions from Virginia sources to his net income, gain, loss, and deduction from all sources.
The Taxpayers, who were nonresidents for the taxable years at issue, filed part-year resident individual income tax returns rather than nonresident income tax returns. Consequently, the Taxpayers must amend their 2003 through 2005 income tax returns to properly report their income and compute the tax as nonresidents.
Nonresident Salaries and Wages
According to the information provided, the husband received a salary from ASC. For salaries and wages from an employer, the "net income, gain, loss, and deductions from Virginia sources" would be an amount equal to (1) the total annual salary from the employer, (2) multiplied by the number of days or portion thereof that the nonresident individual spent in Virginia performing duties for their employer, and (3) divided by the number of days or portion thereof spent anywhere performing duties for the employer. See P.D. 84-90 (7/3/1984).
Nonresident Income From Pass-Through Entities
The Taxpayers reported income from several pass-through entities, including ASC. Pursuant to Va. Code § 58.1-390.1 a "pass-through entity" is defined as:
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- any entity, including a limited partnership, a limited liability partnership, a general partnership, a limited liability company, a professional limited liability company, a business trust or a Subchapter S corporation, that is recognized as a separate entity for federal income tax purposes, in which the partners, members or shareholders report their share of the income, gains, losses, deductions and credits from the entity on their federal income tax returns.
Income from Virginia sources of a pass-through entity is defined to include income from the ownership of an interest in real or tangible personal property in Virginia or income from intangible personal property. Income from intangible personal property includes annuities, dividends, interest, royalties and gains from the disposition of intangible personal property to the extent that such income is from property employed by the taxpayer in a business, trade, profession or occupation carried on in Virginia.
Virginia generally conforms to the federal treatment of pass-through entities. 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. Income from a pass-through entity is allocated or apportioned to Virginia based on the three-factor formula, set forth under Va. Code §§ 58.1-407 through 58.1-421.
Therefore, unless a pass-through entity has a Virginia apportionment factor of zero for a taxable year, the owners receiving a distributive share of income from the entity will have income from Virginia sources. Each individual member or partner is required to file a Virginia individual income tax return to report their income from Virginia sources, regardless of whether the member, shareholder, or partner is a resident or nonresident of Virginia, if the Virginia adjusted gross income from all sources exceeds the applicable filing threshold.
Based on the information provided, it appears that all the pass-though entities have nexus with Virginia. As such, the Taxpayers must report their proportionate share of the income apportioned to Virginia by the pass-through entities as Virginia source income.
CONCLUSION
In accordance with this determination, ASC must file amended returns for the taxable years at issue in order to properly apportion its income to Virginia. The other pass-through entities should do likewise if the apportionment factor reported is incorrect. For the 2003 taxable year, the small business corporation income tax return must be amended and an amended Schedule K-1 must be issued. For the 2004 and 2005 taxable years, amended pass-through entity returns must be filed and amended Schedule K-1 s must be issued.
The Taxpayers must file amended income tax returns to report their income as nonresidents for the 2003 through 2005 taxable years. All returns must be filed within 30 days from the date of this letter. The returns should be mailed to the Virginia Department of Taxation, Office of Policy and Administration, Appeals and Rulings, Post Office Box 27203, Richmond, Virginia 23261-7203, Attention: *****. The assessments will be adjusted as appropriate after the amended returns are processed. If the amended returns are not filed, the current assessments will be deemed to be prima facie correct under Va. Code § 58.1-205. In such case, collection action on the outstanding assessments will resume.
The Code of Virginia section cited, along with other reference documents, 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 response, you may contact ***** at *****.
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- Sincerely,
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- Janie E. Bowen
Tax Commissioner
- Janie E. Bowen
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AR/1-1050076310E
Rulings of the Tax Commissioner