Tax Type
Corporation Income Tax
Individual Income Tax
Description
Corporate and individual income taxes
Topic
Persons Subject to Tax
Taxability of Persons and Transactions
Date Issued
06-29-1988
June 29, 1988
Re: Ruling Request: Income Tax
Dear*****************
This is in reply to your letter of March 24, 1987 and to *************** letter of August 1, 1987, requesting a ruling regarding the application of the Virginia income taxes, both corporate and individual, to your client, *************** and its subsidiaries. I apologize for the delay in responding to your letter and I hope that the delay has not caused you or your client any inconvenience.
FACTS
************* (Operating Partnership) is engaged in the business of wholesale distribution of industrial products. Operating Partnership is assumed to be either engaged in sufficient activities within Virginia to satisfy the minimum nexus requirements set forth in Public Law 86-272, or could become engaged in such activities in the future.
************* (Company), a limited partnership, is the conduit through which cash and distributive items flow from the operating partnership to the partners through a complex organization of partnerships, both general and limited, corporations, both C corporations and S corporations and public investors (individuals, partnerships and corporations) as limited partners.
You have requested a ruling regarding the application of the Virginia income taxes, both corporate and individual, to your client, *********** and its subsidiaries. Rather than answer each of your numerous individual questions, I will couch my response in general terms in regard to the Virginia income tax requirements related to each type of partner (partnership, S corporation, C corporation and individual).
RULING
Partnerships
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. The 1988 Session of the Virginia General Assembly enacted legislation (Chapter 249, 1988 Acts of Assembly) which repealed the partnership return filing requirements set forth in Virginia Code §58.1-392. This change is effective for taxable years beginning on or after January 1, 1987. The repeal of the partnership return filing requirement does not relieve resident or nonresident partners with partnership income from Virginia sources from the filing of Virginia income tax returns.
The Virginia Taxation of Partnerships Regulations (copy enclosed) require that partnerships which have income from business both within and without Virginia compute their Virginia source income in accordance with the corporate statutory formula set forth in Virginia Code §§58.1-408 through 58.1-421 (copies enclosed), making such changes as necessary after considering the differences between corporations and partnerships. Therefore, such partnerships generally must allocate dividends to the state of commercial domicile and apportion all other income. Income is apportioned using a three-factor formula based on the property, payroll and sales within Virginia.
Under federal law, "[t]he 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." [IRC §702(b).] In addition, 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. (Virginia Code §58.1-391 B.) There is no limitation imposed under either federal law or Virginia law regarding the number of tiers of partnerships that may exist.
Thus, if a partnership operates a business in Virginia, any item of partnership income, gain, loss, deduction, or credit will retain its Virginia source character no matter how many partnerships it passes through.
The pass through of Virginia source income will continue to occur from partnership to partner until the income is passed through to a partner which is a taxable entity.
S corporations
Virginia generally conforms to the federal treatment of S corporations. Electing small business corporations which make the election under Subchapter S of the Internal Revenue Code to have the income of the corporation included in the income of the shareholders are exempt from the Virginia corporate income tax. Such corporations are required to file a Virginia return even though exempt from income tax. The same Virginia filing requirements applicable to C corporations are applicable to S corporations.
The Virginia Corporation Income Tax Regulations (copy enclosed) require that every corporation that is organized under the laws of Virginia and every foreign corporation registered with the State Corporation Commission for the privilege of doing business in Virginia must file a return. Furthermore, every corporation having income from Virginia sources must file a return regardless of where it is organized, headquartered or from where it is managed or directed, or where its shareholders reside or whether it has registered with the State Corporation Commission for the privilege of doing business in Virginia. (VR 630-3-441)
These same regulations require corporations (including S corporations) which have income from business both within and without Virginia to compute their Virginia source income in accordance with the corporate statutory formula set forth in Virginia Code §§58.1-408 through 58.1-421. Therefore, such S corporations generally must allocate dividends to the state of commercial domicile and apportion all other income. Income is apportioned using a three-factor formula based on the property, payroll and sales within Virginia.
Under federal law, "[t]he character of any item included in a shareholder's pro rata share ... shall be determined as if such item were realized directly from the source from which realized by the corporation or incurred in the same manner as incurred by the corporation." [IRC §1366(b)] Because of Virginia's conformity to federal income tax law (Virginia Code §58.1-301), each item included in a shareholder's pro rata share has the same character for a shareholder for Virginia income tax purposes as for federal income tax purposes.
Therefore, income received by an S corporation, which is determined to be income from Virginia sources, will remain Virginia source income in the hands of the shareholders. Generally, under federal income tax law, shareholders in an S corporation must be individuals. Accordingly in most cases the income passed through an S corporation is passed through to a taxable entity.
C corporations
Virginia generally conforms to the federal treatment of C corporations. The Virginia Corporation Income Tax Regulations require that every corporation that is organized under the laws of Virginia and every foreign corporation registered with the State Corporation Commission for the privilege of doing business in Virginia must file a return. Furthermore, every corporation having income from Virginia sources must file a return, regardless of where it is organized, headquartered or from where it is managed or directed, or where its shareholders reside or whether it has registered with the State Corporation Commission for the privilege of doing business in Virginia. (VR 630-3-441).
The computation of Virginia taxable income begins with federal taxable income. These same regulations require corporations which have income from business both within and without Virginia to compute their income subject to Virginia tax in accordance with the corporate statutory formula set forth in Virginia Code §§58.1-408 through 58.1-421 and described above.
Under both federal and Virginia law, a C corporation is a taxable entity. Therefore, the C corporation's pro rata share of income from a partnership retains its character as income from Virginia sources. If the C corporation is a general partner, then the corporation's apportionment factors must include the pro rata share of the partnership's property, payroll and sales. See VR 630-3-409 A.2.b.
There is no provision in federal law which specifies that the character of the items of income, gain, loss, deduction, or credit from the corporation retain the same character in the hands of the shareholder as in the hands of the corporation. The shareholder in a C corporation receives dividends. Both federal and Virginia law contain specific provisions regarding the taxation of dividends received by a corporate taxpayer, e.g, IRC §243 and Virginia Code §58.1-402 C.10. In the hands of an individual shareholder, dividends represent unearned investment income.
Individuals
The Virginia individual income tax is imposed (see the exceptions under Virginia Code §58.1-321, copy enclosed) upon individuals based upon their Virginia taxable income. The Virginia taxable income of a resident individual is defined under Virginia Code §58.1-322 as his federal adjusted gross income with certain statutory modifications. The Virginia taxable income of a nonresident of Virginia is defined under Virginia Code §58.1-325 as:
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- 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.
For a nonresident individual who is a shareholder in an electing small business corporation (S corporation), there shall be included in his Virginia taxable income his share of the taxable income of such corporation, and his share of any net operating loss of such corporation shall be deductible from his Virginia taxable income.
- 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.
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- 1. Items of income, gain, loss and deduction attributable to:
a. The ownership of any interest in real or tangible personal property in Virginia; or
b. A business, trade, profession or occupation carried on in Virginia.
2. Income from intangible personal property, including annuities, dividends, interest, royalties and gains from the disposition of intangible personal property to the extent that such income is from property employed by the taxpayer in a business, trade, profession, or occupation carried on in Virginia. (Emphasis added.)
- 1. Items of income, gain, loss and deduction attributable to:
Generally applying the above policies to the facts presented in your ruling request, the share of income apportionable to Virginia from the business carried by the operating Partnership will retain its character as income from Virginia sources as it is passed from partnership to partnership. The taxable entity (individual or C corporation) which ultimately receives such income will be deemed as receiving income from Virginia sources.
If you have any specific questions not answered by this ruling, please feel free to contact the department.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner