Tax Type
Corporation Income Tax
Description
Alternate method of allocation and apportionment; Part-year residents
Topic
Allocation and Apportionment
Date Issued
07-14-1995
July 14, 1995
Re: Request for Ruling:
Dear**************
This will reply to your letter of March 10, 1995, in which you requested permission to use an alternative method of allocation and apportionment on behalf of ********** (the "Taxpayer").
FACTS
The Taxpayer is an S corporation which moved its operations into Virginia in July of 1994. The Taxpayer was originally incorporated outside of Virginia, but merged with a newly created Virginia corporation upon moving to Virginia, thus terminating its corporate charter in the other state. For federal purposes, this transaction is treated as a mere change in identity which does not terminate the federal taxable year. A short period return was filed in the other state reporting the income earned while in such state (January through July). The Taxpayer is requesting permission to use an alternative method of allocation and apportionment since it believes that the statutory method will subject its shareholders to tax on more income than reasonably can be attributed to Virginia for the last 6 months of 1994. The Taxpayer in effect proposes to use separate accounting to determine the amount of income for the period domiciled in Virginia.
RULING
A corporation which has business activity that is taxable both within and without Virginia must allocate and apportion its income in accordance with Code of Virginia §§58.1-406, et seq. Based on the Taxpayer's type of business, the proper method of allocation and apportionment for Virginia tax purposes is the standard three-factor formula of property, payroll, and sales.
Allocation and apportionment for purposes of a S corporation is only applicable to nonresident shareholders. Nonresident shareholders of a S corporation which conducts its business within and without of Virginia include in their income from Virginia sources the portion of their pro rata share of the S corporation's income which is allocated and apportioned in Virginia.
Virginia resident shareholders of an S corporation which conducts its business within and without of Virginia include 100% of their pro rata share of the S corporation's income in their Virginia taxable income. Although allocation and apportionment are not available, Virginia residents are allowed a credit for income taxes paid to other states in accordance with Code of Virginia §58.1-332.
Based on the facts as presented, prior to moving to Virginia, the Taxpayer had no income from Virginia sources. In addition, prior to moving to Virginia, none of the Taxpayer's shareholders (the "Shareholders") were residents of Virginia. Accordingly, based on these assumptions, the Shareholders would not be subject to Virginia income tax as nonresidents for the period of the year during which the Taxpayer and its shareholders were domiciled outside of Virginia.
As of July 1994, the Shareholders became residents of Virginia. Accordingly, the Shareholders must file part-year Virginia resident returns.
Virginia Regulation (VR) 630-2-303 provides that a part-year resident will be taxed as follows:
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- A. Any individual who becomes a domiciliary or actual resident of Virginia during the taxable year or who, before the last day of the taxable year abandons his Virginia domicile, shall be taxed as a resident only for that portion of the taxable year during which he is a resident of Virginia.
D. Any part-year resident who derives income from property owned or business, trade, profession or occupation carried on in Virginia during that portion of the taxable year in which he was a resident of another state or jurisdiction shall be taxed as a nonresident with respect to such income.
- A. Any individual who becomes a domiciliary or actual resident of Virginia during the taxable year or who, before the last day of the taxable year abandons his Virginia domicile, shall be taxed as a resident only for that portion of the taxable year during which he is a resident of Virginia.
The department's historical policy with respect to part-year residents has been to include 100% of the distributive share of income from pass-through type entities in Virginia adjusted gross income if the last day of the entity's taxable year occurred during the period of residency. This policy was based in large part on Internal Revenue Code (I.R.C.) §706, which requires that the taxable income of a partner include his distributive share of partnership income for any taxable year of the partnership which ends with or within his own taxable year. I.R.C. §1366 provides similar treatment for S corporations and their shareholders.
Although the department's historical policy is rooted in federal law, it nevertheless leaves open the possibility that income attributable to periods of nonresidency could become subject to tax by Virginia. In addition, a detailed analysis of federal treatment of nonresident aliens reveals that Virginia's historical policy may in fact be inconsistent with federal law. In Silvio Gutierrez v. Commissioner of Internal Revenue. 53 TC 394, the Tax Court found that the taxable income of a resident alien could not include the portion of a deemed dividend from a foreign personal holding company attributable to periods during which the taxpayer was a nonresident alien. Even though federal law created a deemed distribution on the last day of the taxable year when the taxpayer was a resident, the Tax Court found such a result "extraordinary" and required instead a proration attributable to the period of residency. The federal laws that deem pass-through income to be distributed at a certain time appear to be more applicable to bookkeeping and basis determinations then as to determinations of what income is earned within a given period of residency.
In review of Virginia's policy, the department finds that although it is not unconstitutional to tax a new resident on income from a pass-through type entity which may be attributable to periods prior to residency, Code of Virginia §58.1-303 does not require this interpretation. The policy also results in unequal treatment of new residents versus individuals who move from Virginia before the last day of the pass-through entity's taxable year. Therefore, the department finds it appropriate to change its policy with respect to part-year residents.
Accordingly, a part-year resident with distributive income from a partnership, S corporation, or other pass-through entity must determine income from such entity attributable to periods of Virginia residency and nonresidency by prorating in accordance with the number of days in each period. Where the pass-through entity itself had income from Virginia sources, the distributive share of income attributable to the period of nonresidency shall be taxable to the recipients under the rules applicable to nonresidents. A part-year resident shall not be entitled to a credit for taxes paid to another state with respect to income from a pass-through entity which has been excluded from Virginia source income pursuant to this policy.
In the instant case, the Taxpayer actually terminated its corporate charter in the other state, and filed a final return in such state. The Taxpayer therefore has a clearly defined cut-off of activity occurring before and after the date upon which the Shareholders moved to Virginia. Accordingly, the Shareholders may determine income which is attributable to their period of residence in Virginia by comparing their share of the Taxpayers total federal distributive income to their share of such income which was reported on the final return filed in such other state. However, the Shareholders shall not be entitled to a credit for taxes paid to other states with respect to any income which is so excluded from Virginia source income.
If you have any additional questions regarding this ruling, you may contact**********.
Sincerely,
Danny M. Payne
Tax Commissioner
Tax Commissioner
OTP/9716M
Rulings of the Tax Commissioner