Tax Type
Individual Income Tax
Description
Actions that indicate the Taxpayers changed their domicile
Topic
Partnerships
Residency
Date Issued
03-20-2006
March 20, 2006
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 assessment issued to ************ (the "Taxpayers") for the taxable year ended December 31, 2002. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayers, a husband and a wife, were residents of Virginia where they operated their own business. The Taxpayers owned several rental properties in Virginia, and the husband held a membership interest in ***** ("VALLC").
In 2000, the Taxpayers acquired an apartment in ***** ("Country A"). The husband obtained a driver's license in Country A in 2001, and the Taxpayers relinquished their Virginia driver's licenses in 2002. The business was sold in late 2001, and the Taxpayers' Virginia home was sold in January 2002. The Taxpayers established residency in Country A during 2001 and were assigned primary physicians under Country A's nationalized healthcare system.
The Taxpayers maintained motor vehicles in both Virginia and Country A. The Taxpayers also owned a sailboat located at a marina in ***** ("State A"). The Taxpayers used the State A address for filing federal and state income tax returns.
VALLC was involved in a lawsuit with a business located in ***** ("State B") in 2001 and 2002. The suit delayed the Taxpayers' plan to liquidate the husband's membership. As a result of the lawsuit, VALLC received a substantial settlement from the State B business in 2002. The Taxpayers received their share of the proceeds and the husband's membership was liquidated in December 2002.
An audit by the Department determined that the Taxpayers were domiciliary residents of Virginia for the 2002 taxable year. The auditor also concluded that income passed through from VALLC to the Taxpayers was Virginia source income subject to Virginia individual income tax. As a result, the Department issued an assessment to the Taxpayers for the taxable year ended December 31, 2002.
The Taxpayers contend that they were domiciliary residents of Country A during the taxable year at issue. In addition, they claim that the Department improperly classified the income as Virginia source income. Consequently, the Taxpayers request abatement of the assessment issued for the 2002 taxable year.
DETERMINATION
Residency
Two classes of residents, a domiciliary resident and an actual resident, are set forth in Va. Code § 58.1-302. The domiciliary residence of a person means the permanent place of residence of a taxpayer and the place to which he intends to return even though he may actually reside elsewhere. For a person to change domiciliary residency to another state, that person must intend to abandon his Virginia domicile with no intention of returning to Virginia. Concurrently, that person must acquire a new domicile where that person is physically present with the intention to remain there permanently or indefinitely. An actual resident of Virginia means a person who, for an aggregate of more than 183 days of the taxable year, maintained his place of abode within Virginia. A Virginia domiciliary resident, therefore, working in other parts of the country that has not abandoned his Virginia residency continues to be subject to Virginia taxation. Additionally, a person who is not a domiciliary resident of Virginia, but who stays in Virginia for an aggregate of more than 183 days is also subject to Virginia taxation.
In determining domicile, consideration may be given to the individual's expressed intent, conduct, and all attendant circumstances including, but not limited to, financial independence, profession or employment, income sources, residence of spouse, marital status, sites of real and tangible property, motor vehicle registration and licensing, and such other factors as may be reasonably deemed necessary to determine the person's domicile. A person's true intention must be determined with reference to all of the facts and circumstances of the particular case. A simple declaration is not sufficient to establish domicile.
The Department acknowledges that a change in domicile occurs as part of a process in which no single factor is determinative. The individual has the burden of proving abandonment of his or her Virginia domicile and acquisition of a domicile elsewhere. First, a person must intend to permanently move away from one domicile. Second, the person must acquire a new domicile where he or she intends to remain permanently or indefinitely. If the information is inadequate to meet this burden, the Department will conclude that he or she intended to return to Virginia.
In this case, there are a number of actions that indicate the Taxpayers changed their domicile to Country A prior to the 2002 taxable year. They purchased a residence in Country A in 2000. They joined a local boat club in Country A in January 2001 and opened a bank account. The husband purchased an automobile, obtained a driver's license, and performed other actions to change the Taxpayers' residence to Country A. Country A recognized the Taxpayers as residents for purposes of subsidized medical care. The Taxpayers were issued government identify cards and received medical care through government programs available only to Country A residents. The Taxpayers sold their residence in Virginia in January 2002
The Taxpayers maintained a number of business interests in Virginia, including real estate rental properties and the membership in VALLC. Although they did not spend 183 days in Virginia, the Taxpayers spent more days in Virginia during 2002 than in Country A. In addition, while they did sell their Virginia motor vehicles in 2002, three new motor vehicles were purchased in 2003.
Registering new motor vehicles in Virginia after moving to Country A raises the question as to whether the Taxpayers intended to permanently abandon their Virginia domicile. The information provided indicates that one vehicle was purchased for use in the maintenance of the Taxpayer's rental properties. This vehicle was used almost exclusively by the property manager for business purposes. Another vehicle was purchased to accommodate the husband's medical condition and to transport family when the Taxpayers visit Virginia.
Based on a review of all the relevant factors, I find that the Taxpayers successfully changed their domicile to Country A in January 2002.
Income From Virginia Sources
Virginia Code § 58.1-302 defines income and deductions from Virginia sources to include items of income, gain, loss and deduction attributable to: (1) the ownership of any interest in real or tangible personal property in Virginia; and (2) a business, trade, profession or occupation carried on in Virginia.
Virginia's conformity to federal income tax law is set forth in Va. Code § 58.1-301, which provides that the terms used in the Virginia income tax statutes will have the same meaning as used in the Internal Revenue Code. For Virginia, federal taxable income ("FTI") and federal adjusted gross income ("FAGI"), the starting points for determining income taxable in Virginia for corporations and individuals, respectively, are identical to that as defined by the Internal Revenue Code.
In Public Document ("P.D.") 97-343 (8/28/97), the Department ruled that it would follow the federal election made by a limited liability company pursuant to the "check the box" regulations under Treas. Reg. § 301.7701-1 et seq. In fact, Virginia's conformity statute requires such a ruling because a limited liability company that is treated as a partnership or a disregarded entity for federal income tax purposes will have no federal taxable income as a starting point for computing its Virginia taxable income.
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 ("I.R.C.") § 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 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. This would include a limited liability company that elects to be treated as a partnership for federal income tax purposes.
In this case, VALLC is a limited liability company located in and operating in Virginia that elected to be treated as a partnership for income tax purposes. For the 2002 taxable year, VALLC received income as a result of settling a lawsuit with a State B business. This income was properly reported as ordinary income on VALLC's federal partnership return. Although, the suit was filed in court in State B, no evidence has been provided to show that VALLC had nexus for income tax purposes with any state other than Virginia. Accordingly, all of VALLC's income is considered to be income from Virginia sources.
The Taxpayers reported the income from the lawsuit on their nonresident income tax return as income from sources outside of Virginia. They contend that the proceeds from the settlement of the lawsuit do not represent income from Virginia sources and that the taxation of the proceeds is not permitted under the Due Process and Commerce Clauses of the U.S. Constitution.
Due Process
The operation of the Due Process Clause as a limitation on the taxing power of the states usually involves one of two basic issues: (1) the relationship between the state exercising taxing power and the object of that exercise of power, and (2) whether the degree of contact is sufficient to justify the state's imposition of a particular obligation. In this case, VALLC is headquartered in Virginia and conducts all of its operations in Virginia. Accordingly, the Department is well within its jurisdictional rights to impose tax on the income of VALLC.
Commerce Clause
In evaluating the validity of an income tax under the Commerce Clause, the United States Supreme Court offered a four-pronged test. Under this test, a tax must be: (1) applied to an activity with a substantial nexus with the taxing authority; (2) fairly apportioned; (3) nondiscriminatory to interstate commerce; and (4) fairly related to the services provided by the state or locality. See Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). In the case at hand, it appears that a Commerce Clause analysis is not required the Taxpayers have not shown that VALLC is subject to tax in any state other than Virginia.
The Taxpayers argue that the membership in VALLC is more akin to that of a limited partner. As such, the Taxpayers believe that the income from VALLC should be treated like any other investment income. Because they were not residents of Virginia, the Taxpayers contend that the investment income from VALLC should not be considered Virginia source income.
As a limited liability company, however, VALLC elected to be treated as a partnership for federal income tax purposes on the income earned by a limited liability company. There is no question that the Department would have the express authority to tax the income of VALLC if such tax were imposed at the entity level. Because VALLC was not treated as a separate entity for federal taxation purposes, however, it will not have any FTI. Although VALLC continued its legal existence and business activities, it had no FTI for computing a Virginia taxable income and was not required to file a Virginia income tax return for its 2002 taxable year.
For federal income tax purposes, the members were considered the owners of all VALLC's assets and liabilities. Consequently, the Department regards the members, including the husband, as having the attributes and conducting the activities of VALLC. Because this election was made at the discretion of the members of VALLC, the Department's imposition of tax on VALLC's income on the returns of its members is not prohibited by the Commerce Clause.
Allocation
The Taxpayers further contend that the husband's relationship as a passive investor with VALLC precludes taxation of the VALLC income, and an analysis of his relationship with VALLC is required. The Taxpayers contend that the United States Supreme Court noted that a state may tax certain income of a nondomiciliary, even though the business is not unitary, where the income at issue bears an operational relationship to the taxpayer's in-state activities. See Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992). To that end, the Taxpayers argue that their business activities were not related in any way to VALLC's business activities and that the distribution received pursuant to the settlement represented nothing more than a return on investment in VALLC.
The husband held a membership interest of approximately 20% in VALLC. VALLC's website recognizes the husband as an inventor of its primary product and lists several awards received as a result of the product, for which the husband holds patents. The lawsuit filed by VALLC, which resulted in the income whose source is at issue, was filed as a result of activities by another company with respect to that product.
The question as to the relationship and function of the husband's interest in VALLC is irrelevant to this case. The members made the election to have the income of VALLC passed through to the members for income tax purposes. As stated earlier, under federal law, to which Virginia conforms, the character of the income will not change when passed through to a taxable entity or individual.
Clearly, VALLC had a functional interest in the lawsuit for patent infringement on a product it had developed. In fact, it is likely that VALLC's viability as a going concern would have been significantly impaired if the lawsuit were not successful. Accordingly, the proceeds from the lawsuit were properly included in the ordinary income of VALLC.
Furthermore, without any evidence that VALLC was subject to income tax in any other state, including State B, Virginia is well within its authority to impose tax on the income of VALLC. If, in fact, VALLC had elected to be treated as a corporation, there would be no question as to whether Virginia could impose tax on VALLC's income. The result is no different just because an election was made to pass the income through to its members. As such, pursuant to Va. Code § 58.1-325, I find it appropriate to include all of VALLC's income as income from Virginia sources in determining the Taxpayers' nonresident income tax liability for the 2002 taxable year.
CONCLUSION
The Taxpayers successfully changed their domicile to Country A in January 2002. The income from VALLC was income from Virginia sources for purposes of determining the Taxpayers' nonresident income tax liability. The assessment has been adjusted in accordance with this ruling. See the enclosed schedule.
A revised bill, with interest accrued to date, will be mailed shortly to the Taxpayers. No additional interest will accrue provided the outstanding assessment is paid within 30 days from the date of the revised bill. The Taxpayers should remit their payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attn: *****. If you have any questions concerning payment of the assessment, you may contact ***** at *****.
The Code of Virginia and regulation sections cited 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 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
Tax Commissioner
- Kenneth W. Thorson
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AR/53060E
Rulings of the Tax Commissioner