Tax Type
Individual Income Tax
Description
Tax on distributions received from Corporation A
Topic
Appropriateness of Audit Methodology
Corporate Distributions and Adjustments
Persons Subject to Tax
Records/Returns/Payments
Date Issued
04-17-2008
April 17, 2008
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 assessment issued to your client, ***** (the "Taxpayer"), for the taxable year ended December 31, 2003.
FACTS
The Taxpayer is a shareholder in a Subchapter S corporation (Corporation A) based in ***** (State A) that operates an office in Virginia. For the 2003 taxable year, Corporation A properly filed corporate income tax returns as a Subchapter S Corporation with both the Internal Revenue Service and the Department. Corporation A subsequently filed an amended Virginia S corporation return reporting no distributions to its shareholders and filed a Virginia corporate income tax return as a taxable corporation.
The Taxpayer, a resident of ***** (State B), did not file a Virginia nonresident individual income tax return for the 2003 taxable year. Under audit, the Department issued a tax assessment based on income passed through from Corporation A.
The Taxpayer contests the assessment, asserting that Virginia cannot tax the distributions received from Corporation A. The Taxpayer further contends the assessment was computed incorrectly and requests that the Department waive any penalties remaining in the assessment.
DETERMINATION
S Corporation Income
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 (IRC). 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 I.R.C.
In following federal tax policy with respect to S corporations, Va. Code § 58.1-401 provides that such corporations are not subject to income tax in Virginia. Thus, Virginia has elected to treat S corporations in substantially the same manner as has the Internal Revenue Service, i.e., the corporate entity itself is not subject to taxation, but the shareholders will be taxed as individuals on their pro rata share of S corporation income to the extent includable in FAGI. See Title 23 of the Virginia Administrative Code (VAC) 10-120-90 E.
Corporation A elected to be a Subchapter S corporation for federal income tax purposes; therefore, it is treated as a Subchapter S corporation for Virginia income tax purposes. As such, Corporation A is not permitted to file a Subchapter S corporation return for federal purposes and then file a C corporation return for Virginia purposes. For the 2003 taxable year, it was required to file a Virginia S corporation income tax return and report its shareholders' proportionate share of income.
The Taxpayer argues that the Department accepted Corporation A's amended 2003 corporate income tax return and Virginia corporate income tax payment; therefore, the Department cannot assess tax against the nonresident shareholders. The Department, however, has the authority to investigate any books and records of a taxpayer in order to ascertain the proper tax liability. See Va. Code § 58.1-219. Audits and investigations are usually done either after a taxpayer files a return or after the date a taxpayer was required to file a return. As such, the fact that an amended return is filed and processed does not prohibit the Department from assessing additional tax within the statute of limitations.
The Taxpayer further asserts that because Corporation A paid Virginia income tax, the income distributions to the shareholders cannot be considered Virginia source income. As noted earlier, Virginia's conformity with federal statutes dictates the treatment of Corporation A's income. The fact that Corporation A paid Virginia income tax does not negate Virginia law with regard to the 'taxation of income from S corporations.
Corporation A elected to be a Subchapter S Corporation for federal income tax purposes. Pursuant to Va. Code § 58.1-401, it was exempt from Virginia income taxation for the 2003 taxable year. Corporation A's original corporate income tax return was filed consistent with its federal election and the requirements of Virginia law. The amended returns were improperly filed, and Corporation A overpaid its tax for the 2003 taxable year. The fact that Corporation A paid Virginia income tax with one of the amended returns does not invalidate its exemption from the tax, nor does the payment insulate the shareholders from their tax responsibilities.
The amended return with which the income tax payment was included was filed in May 2004. Pursuant to Va. Code § 58.1-1823, the statute of limitations has expired for Corporation A to claim a refund of the 2003 overpayment.
Nonresident Individuals
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."
The Taxpayer lives and works in State B. He did not perform any services in Virginia during 2003. Accordingly, he asserts that he did not receive any Virginia source income for the 2003 taxable year.
Virginia Code § 58.1-341 requires every nonresident individual having Virginia taxable income to file an income tax return. Virginia Code § 58.1-325 B provides statutory guidance for the treatment of a nonresident shareholder of an S corporation with Virginia activity. It has been the Department's longstanding policy that income received by a Subchapter S corporation, which is determined to be income from Virginia sources, will remain Virginia source income in the hands of the shareholders. See Public Document (P.D.) 88-165 (6/29/1988).
The evidence indicates that Corporation A is located in Virginia and produced Virginia source income. Therefore, Corporation A had income subject to Virginia tax, which was passed through to its shareholders, including the Taxpayer. Accordingly, the Taxpayer is subject to Virginia income tax on the distribution of income from Corporation A.
Virginia Source Income
Under Title 23 VAC 10-110-180 B, income of a nonresident attributable to a business, trade, profession or occupation carried on in Virginia includes income passed through from an S Corporation. Pursuant to P.D. 88-165, when nonresident individuals are shareholders of an S corporation that conducts business in Virginia, the Department applies the provisions of Va. Code §§ 58.1-405 through 58.1-421 in order to determine a nonresident's Virginia source income from the S Corporation.
The assessment for the 2003 taxable year was made based on information available to the Department. The Taxpayer may have additional information (i.e., apportionment information, itemized deductions and exemptions) that would accurately reflect the correct tax for the 2003 taxable year. Therefore, it is recommended that the Taxpayer file a nonresident individual income tax return for the 2003 taxable year.
Penalty
Under Va. Code § 58.1-347, an individual who fails to file a return within the statutory time limit is subject to a penalty of 6% of the assessable tax per month or fraction thereof during which such failure to file continues, not exceeding 30% in the aggregate. The Taxpayer claims that he was examined by the Department for the same issue for previous taxable years and no assessments were issued and requests that the penalty be waived.
Virginia Code § 58.1-105 grants the Tax Commissioner the authority to waive penalty in cases where reasonable cause is demonstrated. Until the assessment is corrected, the Department cannot make a decision as to whether penalty should apply in this case. Once the Taxpayer has filed the appropriate return, the Department can determine whether penalty should be assessed.
CONCLUSION
Based on this determination, the Taxpayer is subject to Virginia income tax and should file a nonresident individual income tax return for the 2003 taxable year. Upon receipt of the Taxpayer's 2003 return, the Department will make the appropriate adjustments to the assessment. The 2003 nonresident income tax return must be filed within 30 days of the date of this letter.
If the Taxpayer fails to file a return, the current outstanding assessment will be upheld and become due and payable. Please send the requested return or payment of the assessment to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attn: *****.
Virginia law does provide a mechanism for a pass-through entity, such as an S Corporation, to file and pay Virginia income tax on behalf of its owners (shareholders). Virginia Code § 58.1-395 provides that the Tax Commissioner may grant permission to pass-through entities to file a statement of combined pass-through entity income attributable to nonresident owners. If the shareholders of Corporation A are interested in filing a unified nonresident individual income tax return on behalf of its nonresident shareholders, it may send a request to Tax Commissioner, Virginia Department of Taxation, P.O. Box 2475, Richmond, VA 23218-2475.
The Code of Virginia sections, regulation and public document cited, as well as forms and 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 determination, you may contact ***** at *****.
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- Sincerely,
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Janie E. Bowen
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- Tax Commissioner
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AR/1-623232528.B
Rulings of the Tax Commissioner