Tax Type
Individual Income Tax
Description
Taxation of nonresidents; S corporation shareholders
Topic
Taxpayers' Remedies
Date Issued
03-05-1993
March 5, 1993
Re: Request for Ruling: Individual Income Tax
Dear********
This will reply to your letter of December 20, 1992 in which you request a ruling regarding the applicability of the Virginia individual income tax to nonresidents who receive intangible income earned by a Virginia S corporation and related reporting matters.
FACTS
An S corporation (the "Corporation"), which is based in Virginia, primarily earns interest and dividends from investing in the various financial markets. The income earned by the corporation is passed through to its sole shareholder who is not a resident of Virginia (the "Shareholder").
The Corporation employs an accountant to oversee the portfolio, collect income earned and prepare financial statements. Such operations are performed in Virginia. Additionally, the corporation consults with investment advisors and counselors for financial guidance.
You have asked the department to determine whether Virginia will tax the Shareholder on the income earned by the Corporation. Additionally, you have asked the department to respond to several technical questions in the event that the Shareholder is subject to Virginia taxation.
RULING
Taxation of Nonresidents
Virginia taxes nonresidents on the income they earn from Virginia sources. Pursuant to Va. Code §58.1-325 (copy enclosed), a nonresident shareholder of a Virginia S corporation is required to include in the income he reports to Virginia his pro rata share of S corporation income. Va. Code §58.1-302 (copy enclosed) includes in its definition of Virginia source income intangible income that results from property employed in a business carried on in Virginia.
The Corporation conducts operations from its Virginia location. Its activities in Virginia include the monitoring of investments, collecting income, banking related matters, and the preparation of financial statements and cash flow analyses. These activities constitute a business in Virginia for tax purposes.
The income derived from such activities is, therefore, Virginia source income. Va. Code §58.1-302. Such income is taxable by Virginia despite the fact that it is intangible and that it is passed through to the Shareholder. In this case the Shareholder is required to report the income to Virginia and pay the appropriate amount of tax on such income.
In your letter you contend that if the Shareholder hired an independent investment company located in Virginia, the nonresident Shareholder would not be taxed on the interest and dividends earned. While this may be true, your contention ignores the other side of the transaction. The investment company that conducts its operations in Virginia would be subject to Virginia tax on its earnings. Under the Virginia taxing structure, an S corporation will avoid the imposition of tax at the corporate level, however, the situs of income will not change merely because such income is passed through to its shareholders.
Apportioning S Corporate Income to Virginia
The amount of income earned by the Corporation that will be subject to Virginia taxation may be an amount less than 100% of the income earned by the Corporation. Pursuant to Va. Code §58.1-418 (copy enclosed), a financial corporation is a corporation that earns more than 70% of its income from interest, dividends, and gross profits from trading financial instruments. Financial corporations are required to apportion income to Virginia based upon the cost of performance in the Commonwealth as compared to its cost of performance everywhere.
Since most of the Corporation's earnings are from interest and dividends, it is a financial corporation for purposes of apportioning income to Virginia. The amount of income apportioned to Virginia is equal to the product of the percent of the costs the Corporation incurs in Virginia as compared to its operations everywhere multiplied by the Corporation's gross income. Assuming the Corporation incurs 85% of its cost in Virginia, 85% of its income will be subject to taxation by Virginia.
Reporting Income to Virginia
Finally, you inquired into how the Shareholder is to report the income and the related expenses to Virginia if the department determines that the Corporation's income is taxable in Virginia.
Based upon your description of the federal tax filing requirements, the Shareholder reports the gross amount of the Corporation's income earned on the income section of federal Form 1040. Be reports the Corporation's expenses on federal Schedule A as an "Other Miscellaneous Deduction" which is only deductible to the extent that such items are in excess of two percent of Federal Adjusted Gross Income (FAGI). In most instances a taxpayer that owns stock in an S corporation which is not an investment company, reports the net income in the income section of the federal tax return.
Generally, for purposes of determining the percent of a nonresident's income which is taxable by Virginia, the income included in the FAGI is allocated between Virginia and everywhere else. Carrying over the investment income from an S corporation to the Virginia nonresident return would result in an overstatement of the percentage of the nonresident's income subject to Virginia taxation. To rectify this discrepancy, a special adjustment is required.
A nonresident should, on a separate schedule, which should be attached to his Virginia return, deduct from the gross investment income those expenses directly related to acquiring the income. The adjusted investment income amount is reported in Part V, Nonresident Allocation Percentage Schedule of Form 763, Virginia Nonresident Income Tax Return (copy with instruction enclosed). This adjustment should remedy any inconsistency that is created by the federal reporting requirements.
The Shareholder is, therefore, required to file a nonresident return and make the special adjustment as described herein. If you have any further questions please do not hesitate to
contact the department.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/5946O
Rulings of the Tax Commissioner