Tax Type
Individual Income Tax
Description
Taxpayer failed to provide information of sole proprietorship's sales
Topic
Assessment
Date Issued
07-02-2007
July 2, 2007
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 assessments issued to ***** (the "Taxpayer") for the taxable years ended December 31, 1998 and 1999.
FACTS
The Taxpayer, a resident of ***** ("State A"), operates as a commercial real estate broker. He is a sole proprietor and reports the income from his business on Schedule C of his federal income tax return. The Taxpayer does not typically list real estate properties for sale. Instead, he contracts with businesses to identify potential sites for commercial development. The Taxpayer earns a commission based on the sales price of the real estate purchased by his business client.
The Taxpayer represented buyers on three separate sales of Virginia real property in 1998 and two separate sales of Virginia real property in 1999. The Taxpayer spent a portion of the time required to complete each of these sales in Virginia.
The Department determined that the Taxpayer had Virginia source income from business conducted in Virginia and requested that he file Virginia individual income tax returns for the taxable years at issue. The Taxpayer subsequently filed Virginia nonresident income tax returns that apportioned the commissions earned from the sale of the Virginia real estate to Virginia based on the number of days that the Taxpayer was in Virginia working on the particular transaction.
Under audit, the Department requested information in order to apportion the Taxpayer's real estate business income. When the Taxpayer failed to produce the information, all of the income from the real estate sole proprietorship was attributed to Virginia and assessments were issued. The Taxpayer contests the assessments, arguing that his activities in Virginia were not sufficient to establish nexus. Further, the Taxpayer asserts that, even if nexus were established, the Department's regulations and rulings only support the imposition of tax based on the percentage of time the Taxpayer spent in Virginia on business.
DETERMINATION
Nexus
The Taxpayer contends that his infrequent sales trips into Virginia were insufficient to create nexus for income taxation. He cites Commonwealth of Virginia v. B.J. McAdams, 227 Va. 548, 317 S.E.2d 788 (1984) in support of his argument.
It is well established that a state may tax income derived from property located within such state and business transacted within such state that is owned and managed from without by a citizen and resident of another state. See Shaffer v. Carter, State Auditor, et al., 252 U.S. 37 (1920). Based on the facts presented, the Taxpayer clearly has Virginia source income within the meaning of the Code of Virginia.
Federal law does prohibit 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. See Public Law (P.L.) 86-272, codified at 15 U.S.C. § 381-384.
In this situation, the Taxpayer is engaged in the sale of services, which are clearly outside the federal statutory protection of P.L. 86-272. The Department, however, applies P.L. 86-272 to the solicitation of sales of other than tangible personal property. See Public Document (P.D.) 93-75 (3/17/1993).
Unlike the businesses addressed under federal law, the Taxpayer's business involves more than the mere solicitation of orders from customers in the Commonwealth. In the case of real estate, the object of the activity is always present in Virginia. Any of the services involving the real estate would require services to occur within the Commonwealth. For example, the Taxpayer entered Virginia looking for real property suitable for commercial development, researched local records in Virginia, inspected sites with his clients in Virginia, and generated income from the sale of real property located in Virginia. Accordingly, federal law does not preclude the imposition of Virginia income tax on the Taxpayer.
Virginia Source Income
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." Under Va. Code § 58.1-302, "income and deductions from Virginia sources" includes income from "[a] business, trade profession or occupation carried on in Virginia." As such, the Taxpayer has income from Virginia sources because he acted as a buyer's agent by locating real property in Virginia for his clients.
Generally, nonresident individuals who perform services both within and without Virginia must compute their Virginia source income by apportioning their income between Virginia and the other states in which they produce income. Such apportionment should be based upon factors that most equitably determine the individual's portion of total income that is attributable to services performed in Virginia.
The Tax Commissioner has determined that is most equitable to apportion income earned by certain nonresident employees who perform services both within and without Virginia on the basis of the ratio of work days spent within Virginia to the total number of work days. This apportionment ratio has been applied to boat captains in P.D. 88-256 (9/9/1988), professional athletes in P.D. 89-151 (4/28/1989) and stockbrokers in P.D. 94-280 (9/14/1994). Typically, salaries and wages are apportioned using the number of days worked. This method is most equitable for individuals who earn salaries and wages uniformly through the year. This method is also more equitable for stockbrokers because even though they earn commissions from sales, they cannot specifically identify the location of individual transactions.
In addition, the Tax Commissioner has determined it is most equitable to apportion income earned by nonresident truck drivers, who drive both within and without Virginia, on the basis of the ratio of miles driven in Virginia to the total number of miles driven everywhere. See P.D. 90-120 (8/1/1990). This method produced the closest estimate as to where truck drivers performed their work.
According to Black's Law Dictionary 1427 (8th ed. 1999), a sole proprietorship is a business in which one individual owns all the assets, owes all the liabilities and operates in their own capacity. Unlike employees, an individual operating a sole proprietorship is operating as a business.
The Taxpayer argues that the most equitable way to apportion the income generated from the commission from the sale of the Virginia properties is the ratio of days worked in Virginia to the total number of days worked. The results from business operations cannot, however, be directly related to days where an individual works. This method does not account for days that the Taxpayer spent working on real estate deals that did not close. Further, business income has generally been apportioned based on activities occurring during the taxable year it is recognized. Under this general practice, a method based on days could produce inequitable results when an income generating activity spans multiple years. In addition, the number of days spent on revenue generating activity does not necessarily correlate to the value of the resulting transactions. Thus, the method proposed by the Taxpayer is not the most equitable way to apportion commission income generated from real estate sales.
Title 23 of the Virginia Administrative Code (VAC) 10-110-180 defines "net income, gain, loss and deductions from Virginia sources" to be such items "attributable to property within Virginia, or to the conduct of a trade, business, occupation or profession within Virginia." When a sole proprietorship conducts a trade or business both within and without Virginia, the Department has found that attributing income based on where its business is transacted to be the most equitable way to attribute net income, gain, loss and deductions among the states. Under this analysis, the Department has typically apportioned income from a sole proprietorship based on the location of the sales or revenues, or a single sales factor.
In this case, the Taxpayer generates commissions based on sales of real estate. Under the Department's longstanding policy, receipts from the sale of real estate are attributed to the state in which the real estate is located even if the actual activities in connection with the sale were not performed in Virginia. See P.D. 88-315 (11/30/1988). Accordingly, the most equitable way to apportion commission income generated from sales of real estate would be on the basis of the ratio of sales of real estate in Virginia to all real estate sales.
CONCLUSION
The Taxpayer failed to provide information concerning the sole proprietorship's sales during the taxable years at issue. The Department's assessments, therefore, were issued based on estimates pursuant to Va. Code § 58.1-111.
Based on this determination, the audit will be returned to the audit staff. The Taxpayer will be given 30 days from the date of this letter to provide the audit staff with the documentation that shows the gross receipts of all real estate sales and the gross receipts of Virginia sales for the taxable years at issue. Based on the documentation the Taxpayer provides, the audit staff will make any necessary adjustments to the assessment. If the requested documentation is not furnished within the allotted time, the assessments will be upheld and an updated bill, with interest accrued to date, will be mailed to the Taxpayer and collection action will resume.
The Code of Virginia sections and public documents 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 regarding this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
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- Sincerely,
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- Janie E. Bowen
Tax Commissioner
- Janie E. Bowen
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AR/1-293312007B
Rulings of the Tax Commissioner