Tax Type
Individual Income Tax
Description
Distribution of passive income from rental real estate limited partnership
Topic
Credits
Payment and Refund
Date Issued
02-25-2005
February 25, 2005
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will respond to your letter in which you request a refund with respect to the denial of the out-of-state tax credit claimed on the amended 1999 Virginia individual income tax return filed by ***** (the "Taxpayers"). I apologize for the delay in the Department's response.
FACTS
The Taxpayers (a husband and wife) are domiciliary residents of Virginia. The Taxpayers were limited partners in partnerships engaged in the rental of real estate in ***** ("State A"). The Taxpayers reported all the income on their Virginia individual income tax return, but did not file and report the applicable income to State A.
When contacted by State A, the Taxpayers filed a 1999 State A nonresident individual income tax return and paid the tax. The Taxpayers then filed an amended Virginia individual income tax return on which they claimed credit for income taxes paid to State A. The Department denied the credit because the income was not earned or business income.
The Taxpayers contest the Department's denial of the credit for taxes paid to another state and request a refund, asserting that the income on which the credit is based is business income.
DETERMINATION
For the taxable year at issue, Va. Code § 58.1-332 A provided individuals a credit for income tax paid to another state, as follows:
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Whenever a Virginia resident has become liable to another state for income tax on any earned or business income or any gain on the sale of a principal residence (within the meaning of § 1034 of the Internal Revenue Code) to the extent that such gain is included in federal adjusted gross income, for the taxable year, derived from sources outside the Commonwealth and subject to taxation under this chapter, the amount of such tax payable by him shall, upon proof of such payment, be credited on the taxpayer's return with the income tax so paid to another state. [Emphasis added.]
Title 23 of the Virginia Administrative Code ("VAC") 10-110-221 defines "business income" as income derived from an activity that constitutes a "business" for federal income tax purposes for which a federal Schedule C, E, or F must be filed. The Department has ruled that this definition contemplates a taxpayer engaging in a continuous and regular course of business. See Public Document ("P.D.") 95-157 (6/16/95).
Virginia generally conforms to the federal treatment of partnerships. A partnership, as such, is not subject to income tax. Any income tax arising from the income of the partnership is the liability of the partners. Internal Revenue Code (IRC) § 702(b) states, "The character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share . . . shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership." Each item of partnership income, gain, loss or deduction has the same character for a partner for Virginia income tax purposes as for federal income tax purposes. See Va. Code § 58.1-391 B.
The credit claimed by the Taxpayers for income tax paid to State A was disallowed because the income did not appear to constitute business income. The Taxpayers contend the partnership was engaged in an active trade or business, and the income distribution is business income within the meaning of the statute.
The Taxpayers, as limited partners, had no rights in connection with management of partnership business. The Internal Revenue Service provides that income distributed through rental real estate partnerships to its limited partners is generally considered to be passive income. See IRC § 469 (h)(2). Likewise, the Department considers such income to be passive income, analogous to investment income, when distributed to a limited partner.
Accordingly, the distribution of passive income from the rental real estate limited partnership to the Taxpayers does not constitute business income for purposes of Va. Code § 58.1-332 A. Therefore, the Department's adjustment disallowing the credit for income tax paid to another state is correct, and your request for refund is denied.
It should be noted that Va. Code § 58.1-332 A was amended by the Virginia General Assembly in 1999. Effective for taxable years beginning on and after January 1, 2000, the credit for income tax paid to another state may be computed on the gain on the sale of a capital asset not used in a trade or business. This 1999 legislative change was not available for 1999 individual income tax returns, including the Taxpayer's amended return at issue in this case.
The Code of Virginia sections and regulations cited, along with other reference documents, are available on-line in the Tax Policy Library section of the Department's web site, located at www.policylibrary.tax.virginia.gov. If you have any questions about this determination, you may contact ****** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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Kenneth W. Thorson
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AR/45470E
Rulings of the Tax Commissioner