If a South Carolina resident sells an interest in a partnership that does business in several states, is the whole gain taxed by South Carolina, or only part of it?

Plain-English summary

A South Carolina resident had been an active owner in a tiered pass-through structure — he was a partner in a "Management Partnership" that owned 49% of an "Operating Partnership" (a metal-alloy business operating in several states, including South Carolina). He worked as president until retiring, kept limited involvement, and in 2021 sold his partnership interest for a $2.6 million long-term capital gain, which he reported entirely to South Carolina. He asked the Department whether the whole gain is really South Carolina income or whether part of it is out-of-state.

The Department's answer turns on allocation vs. apportionment. South Carolina adopts the federal partnership rules (Subchapter K) and then, under Article 17 of Chapter 6, taxes income allocated to the state plus income apportioned to the state [§ 12-6-600].

• Allocation: § 12-6-2220(5) sends gains from selling intangible personal property (a partnership interest is intangible property) to the individual's domicile — but only if the intangible is NOT connected with the taxpayer's business. Gains from intangibles that are connected with the business are not allocated that way.
• Because of the pass-through principle, a partner is in the business of the partnership (the Department cites Ellis v. S.C. Tax Commission: each item of partnership income keeps its character "as if realized directly by the partner"). So the partnership interest was connected with the taxpayer's business, and the gain is not allocated to South Carolina under § 12-6-2220(5).
• Apportionment: gain that isn't directly allocated is instead apportioned among the states where the business was conducted [§ 12-6-2240]. The partnerships' South Carolina apportionment ratio was 2.4% in the year of sale, so the taxpayer should apportion 2.4% of the non-allocated gain to South Carolina — far less than the 100% he reported. (The Department couldn't say whether any part of the gain was otherwise directly allocable, because no information was provided about the partnerships' assets.)

Then there's character — capital vs. ordinary — set by federal law the state has adopted:

• IRC § 741 generally makes gain on the sale of a partnership interest capital gain, except as changed by IRC § 751.
• IRC § 751 ("hot assets") converts the portion of the gain attributable to the partnership's unrealized receivables and inventory from capital into ordinary income. With no asset information, the Department couldn't fix the split, but instructed: to the extent gain is attributable to § 751 assets, report it as ordinary; the remainder is capital.
• Finally, only the South Carolina portion of the capital gain counts as long-term capital gain for South Carolina's 44% net capital gain deduction [§ 12-6-1150].

What this means for you

Partners and LLC members selling an interest (especially resident individuals)

Don't assume that because you're a South Carolina resident, all of your gain on selling a multistate partnership interest is South Carolina income. Where the partnership interest is connected with your business (which the pass-through principle generally makes true for an active partner), the gain is apportioned using the partnership's state apportionment factor — often a small fraction — rather than fully taxed at your home state. Getting this wrong (as the taxpayer here did) can mean substantially over-reporting to South Carolina.

Accountants and tax professionals

Two moving parts to run: (1) sourcing — test whether § 12-6-2220(5) allocates the intangible gain to domicile (only if not connected with the business); for an active partner, Ellis and the pass-through principle push toward "connected," which means apportionment via § 12-6-2240 at the partnership's SC ratio; and (2) character — apply IRC §§ 741/751 to split ordinary ("hot asset") from capital, and remember only the SC-sourced capital gain feeds the § 12-6-1150 44% deduction. The Department repeatedly flagged that missing asset data prevented a full answer, so document the partnership's assets and any direct-allocation items (§§ 12-6-2220/-2230) to support your position.

Common questions

Q: I'm a South Carolina resident who sold a partnership interest. Is the whole gain South Carolina income?
A: Not necessarily. If the interest was connected with your business (typical for an active partner), the gain is apportioned among the states where the partnership operated, using the partnership's apportionment factor — in this ruling, 2.4% to South Carolina.

Q: Why isn't it just taxed where I live?
A: The domicile allocation in § 12-6-2220(5) only applies to intangible-property gains not connected with your business. Under the pass-through principle a partner is in the business of the partnership, so the interest is connected with the business and the gain is apportioned instead.

Q: Is my gain capital or ordinary?
A: Under IRC § 741 it's generally capital, but IRC § 751 recharacterizes the part tied to the partnership's unrealized receivables and inventory ("hot assets") as ordinary income. You need the partnership's asset details to split it.

Q: Does the 44% capital gain deduction apply to the whole gain?
A: Only the South Carolina portion of the long-term capital gain is included in the net capital gain eligible for South Carolina's 44% deduction under § 12-6-1150.

Citations and references

Statutes:

• S.C. Code Ann. § 12-6-600 — adoption of Subchapter K; tax on income allocated and apportioned under Article 17
• S.C. Code Ann. § 12-6-2220(5) — allocates gains from intangibles not connected with the taxpayer's business to domicile
• S.C. Code Ann. §§ 12-6-2210, -2230, -2240 — allocation and apportionment of business income
• S.C. Code Ann. § 12-6-1150 — 44% net capital gain deduction
• I.R.C. § 741 — sale of a partnership interest generally yields capital gain/loss
• I.R.C. § 751 — unrealized receivables and inventory ("hot assets") recharacterized as ordinary income

Case discussed in prose (not linked): Ellis v. S.C. Tax Commission, 280 S.C. 65, 309 S.E.2d 761 (1983) (the partnership pass-through principle — each item keeps its character as if realized directly by the partner).

Source

• Landing page: SC Advisory Opinion Search
• Original PDF: PLR24-1.pdf

Original ruling text

STATE OF SOUTH CAROLINA

DEPARTMENT OF REVENUE
300A Outlet Pointe Blvd., Columbia, South Carolina 29210
P.O. Box 125, Columbia, South Carolina 29214-0575

SC PRIVATE LETTER RULING #24-1
SUBJECT:

Sale of a Partnership Interest
(Income Tax)

REFERENCES:

S.C. Code Ann. § 12-6-600
S.C. Code Ann. §§ 12-6-2210, -2220, and -2240
I.R.C. §§ 741 and 751

AUTHORITY:

S.C. Code Ann. § 12-4-320
S.C. Code Ann. § 1-23-10(4)
S.C. Revenue Procedure #09-3

SCOPE:

A Private Letter Ruling is an advisory opinion issued to a specific taxpayer
by the Department to apply principles of law to a specific set of facts or a
particular tax situation. It is the Department’s opinion limited to the specific
facts set forth by the taxpayer. Moreover, it is binding on agency personnel
only with respect to the taxpayer and only until superseded or modified by
a change in statute, regulation, court decision, or another Departmental
advisory opinion, provided the representations made in the request reflect
an accurate statement of the material facts.

QUESTION:
How should the Taxpayer’s sale of an interest in a multistate partnership that does business in
South Carolina be reported to South Carolina for income tax purposes?
FACTS:
The Taxpayer, a South Carolina resident individual, was an active owner of a tiered pass through
entity structure comprised of two limited liability companies that are treated as partnerships for
tax purposes. 1 The Taxpayer was a partner in “Management Partnership,” which owned 49% of
“Operating Partnership” (“Management Partnership” and “Operating Partnership” are together
referred to as the “Partnerships”).

Partnerships include LLCs that have elected to be taxed as partnerships under the check-the-box regulations found
in Section 301.7701-3 of the Treasury Regulations. See S.C. Code Ann. § 12-2-25(A). For clarity in this private
letter ruling the entities will be referred to as partnerships and the owners as partners.
1

1

The Partnerships conducted business in multiple states, including South Carolina. Operating
Partnership was in the business of buying and selling metal alloys. Management Partnership was
responsible for carrying out managerial functions for Operating Partnership’s business. These
functions included business performance reviews; strategic planning; personnel development; and
managing supplier and customer relations. Management Partnership received pass through income
from Operating Partnership, which was in turn passed through to its partners (including the
Taxpayer).
The Taxpayer worked full time as president and executive officer of Management Partnership until
he retired at the end of 2013. After retirement, he continued to take part in certain managerial
functions on a more limited basis until 2021. In 2021, the Taxpayer sold his interest in Management
Partnership. As a result of the sale, the Taxpayer reported a $2.6 million long term capital gain
entirely to South Carolina.
In the year of the sale, the Partnerships’ South Carolina apportionment ratio was 2.4%. No
information was provided about the assets the Partnerships owned at the time of the sale.
The Taxpayer asks if the entire $2.6 million gain on the sale of his partnership interest is a South
Carolina gain, or whether a portion of the gain is “out-of-state income/gain.”
ANALYSIS:
Allocation and Apportionment:
South Carolina adopts the Internal Revenue Code (IRC) with certain modifications noted in S.C.
Code Ann. §§ 12-6-40 and -50. Specifically, South Carolina adopts Subchapter K of the IRC,
which governs taxation of partners and partnerships, subject to allocation and apportionment as
provided in Article 17 of Chapter 6 of the South Carolina Code. S.C. Code Ann. § 12-6-600. South
Carolina taxes income allocated to this State plus income apportioned to this State.
S.C. Code Ann. §§ 12-6-2220 and -2230 list certain types of income directly allocated for South
Carolina income tax purposes. Any income that is not directly allocated is apportioned 2 among the
states in which the business is conducted, with South Carolina taxing an amount representing the
portion of the business carried on within the State. 3
S.C. Code Ann. § 12-6-2220(5) allocates “gains and losses from sales of intangible personal
property4 not connected with the business of the taxpayer” to the domicile of an individual
taxpayer; but it does not allocate gains and losses from sales of intangible personal property
connected with the taxpayer’s business. Therefore, it must be determined whether the gain from
the sale of intangible personal property (partnership interest) was connected with the “business of
the taxpayer.”
2

See S.C. Code Ann. § 12-6-2240.

3

See S.C. Code Ann. § 12-6-2210(B).

4

A partnership interest is intangible personal property.

2

As a partner, the Taxpayer is in the business of the partnership by reason of the pass through
principle. Under this principle, partnership income or loss is not taxed at the entity level, but is
passed through to the partners to be included on the partners’ returns. The court in Ellis v. South
Carolina Tax Commission 5 relied on the pass through principle and held “…the character of any
item of income, gain, loss deduction or credit included in a partner’s distributive share of gains
and losses shall be the same as if such item was realized directly from the source from which
realized or incurred by the partnership. In other words, each item… is treated as if it were realized
or incurred by the partner directly from the source without ever having passed through the
partnership.” The partnership interest therefore was connected with the Taxpayer’s business.
Accordingly, the gain from the sale is not allocated to South Carolina under S.C. Code Ann. § 126-2220(5).
It is not possible to determine whether any part of the gain is otherwise allocable under S.C. Code
Ann. §§ 12-6-2220 and -2230 because no information is available about the nature of the assets
owned by the Partnerships. However, any amount of gain that is not allocated should be
apportioned among the states where the business was conducted, including South Carolina, as
required by S.C. Code Ann. § 12-6-2240.
The proportion of the business carried on within this State was 2.4% in the year of the sale, so the
Taxpayer should apportion 2.4% of the non-allocated gain on the sale of his partnership interest to
South Carolina.
Character:
As noted, South Carolina has adopted Subchapter K of the IRC. For South Carolina income tax
purposes, IRC §§ 741 and 751 determine the character of the gain from the sale of a partnership
interest.
IRC § 741 generally treats the gain or loss on the sale of a partnership interest as gain or loss from
the sale of a capital asset, except as otherwise provided in IRC § 751 (relating to “unrealized
receivables” and “inventory items”). If the partnership owns IRC § 751 property at the time of the
sale, the character of the portion of the partner’s gain attributable to the IRC § 751 property is
changed from capital to ordinary.
Because no information was provided about the Partnerships’ assets at the time of the sale, the
Department cannot give an opinion on the proper characterization of the South Carolina gain. To
the extent any of the gain is attributable to assets described in IRC § 751, the Taxpayer should
report those amounts as ordinary income. The remainder of the gain, if any, is capital.
CONCLUSION:
The proportion of the Taxpayer’s business carried on within South Carolina was 2.4% in the year
of the sale, so the Taxpayer should apportion to this State 2.4% of any portion of the gain that is
not directly allocated under S.C. Code Ann. §§ 12-6-2220 or -2230.
5

280 S.C. 65, 67, 309 S.E.2d 761-763 (1983).

3

In addition, if the Partnerships owned any IRC § 751 assets at the time of the sale, the portion of
the Taxpayer’s gain attributable to those assets should be reported as ordinary income. The
remainder of the gain, if any, should be reported as long term capital gain. Only the South Carolina
portion of the capital gain is included as a long term capital gain in determining the taxpayer’s net
capital gain eligible for the 44% deduction in S.C. Code Ann. § 12-6-1150.
SOUTH CAROLINA DEPARTMENT OF REVENUE

s/W. Hartley Powell
W. Hartley Powell, Director
February 21
, 2024
Columbia, South Carolina
CAVEAT: This advisory opinion is issued to the taxpayer requesting it on the assumption
that the taxpayer’s facts and circumstances, as stated, are correct. If the facts and
circumstances given are not correct, or if they change, then the taxpayer requesting the
advisory opinion may not rely on it. If the taxpayer relies on this advisory opinion, and the
Department discovers, upon examination, that the facts and circumstances are different in
any material respect from the facts and circumstances given in this advisory opinion, then
the advisory opinion will not afford the taxpayer any protection. It should be noted that
subsequent to the publication of this advisory opinion, changes in a statute, a regulation, or
case law could void the advisory opinion.

4