July 21, 2022
Re: Request for Ruling: Pass-Through Entity Withholding
Dear *****:
This will reply to your letter in which you request whether ***** (the “Taxpayer”), a pass-through entity, is required to withhold tax from a nonresident individual whose ownership interest in the Taxpayer is held by an Individual Retirement Account (IRA).
FACTS
The Taxpayer had income allocable to Virginia as a result of the sale of rental real estate in 2020. The Taxpayer has individual owners who reside outside of Virginia. Several of the ownership interests are held in IRAs. The Taxpayer seeks a ruling as to whether tax must be withheld from the owners whose interests are held by IRAs.
RULING
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 Virginia Code § 58.1-486.2 B 1.
Under Virginia 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 Virginia 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-through entities.” As such, owners are subject to tax on their distributive share of items of income, gain, loss, deduction, or credit of the pass-through entity. Therefore, when nonresidents are owners of pass-through entities, the pass-through entity must compute, report and remit withholding tax. See Virginia Code § 58.1-486.1 A, and the Guidelines for Pass-Through Entity Withholding, issued as Public Document (P.D.) 15-240 (12/12/2015).
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. 15-240. 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).
In accordance with P.D. 15-240, pass-through entities that are exempt from federal and Virginia income tax are not required to withhold. Pursuant to Internal Revenue Code (IRC) § 408(e), IRAs are generally not subject to federal income tax, but may be subject to income tax on unrelated business taxable income (UBTI).
If the Taxpayer is engaged in a trade or business, then the IRAs that purchased a limited partnership interest may have UBTI. In addition, a portion of any capital gains realized from a sale of real estate that was financed with debt would be reported as unrelated debt financed income (UDFI) under IRC § 514. Accordingly, the Taxpayer may have to withhold tax from the nonresident owners of the IRAs if the IRAs have UBTI or UDFI.
This response is based on the facts provided as summarized above. Further because the determination as to whether an IRA is considered to have UBTI is a federal tax matter, the Department cannot render an opinion as to whether the Taxpayer is required to withhold Virginia income tax for income passed through to IRAs. Further, any change in facts or the introduction of new facts may lead to a different result.
The Code of Virginia sections and public documents 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 ruling, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/3890.B