After an S corporation's sole owner moved away, would Virginia tax the owner's share of corporate income and salary tied to continued Virginia sales work?

Subject

Income of an S corporation and compensation paid to the sole nonresident shareholder

Plain-English summary

Virginia ruled that the S corporation would retain income-tax nexus after its sole owner moved away because the owner would continue regular Virginia sales and administrative activity. The nonresident owner would owe tax on the Virginia-source portions of both pass-through income and any salary.

The corporation served as an exclusive Virginia sales agent for an unrelated seller. After moving, the owner planned to travel back as needed to solicit and administer sales. Because the corporation sold services and the in-state work served business functions beyond protected solicitation, Virginia found the activity regular and more than de minimis.

The S corporation itself was not subject to Virginia income tax, but its income had to be apportioned between Virginia and the new state. The owner then included the Virginia-source pass-through share on a nonresident return. Movable company property used in Virginia affected the property factor, while commissions followed the cost-of-performance rule described in the ruling.

If the corporation paid salary, the owner allocated it using Virginia workdays divided by total workdays. The source did not state the compensation method, so it did not compute an amount.

What this means for you

• Moving the owner does not move the business when regular customer-facing work continues in Virginia.
• Service activity may fall outside P.L. 86-272 even when described as sales solicitation.
• Separate pass-through income apportionment from employee wage allocation.
• Track travel days, duties, movable property, commissions, and compensation records.

Common questions

Did the S corporation itself pay Virginia income tax? No. Virginia taxed the shareholder on the apportioned pass-through income.

Was all corporate income Virginia-source? No. The ruling required standard apportionment between Virginia and State A.

How was salary allocated? By Virginia workdays divided by total workdays under the cited method.

Citations and references

• 15 U.S.C. §§ 381-384.
• Va. Code § 58.1-401, § 58.1-325(B), § 58.1-341, and § 58.1-321.
• 23 VAC 10-110-180(B).
• Va. Code §§ 58.1-407 through 58.1-416.
• Wisconsin Department of Revenue v. William Wrigley, Jr. Co., 505 U.S. 214 (1992).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 07-130

Original ruling text

August 18, 2007

Re: Request for Ruling: Individual Income Tax

Dear *:

This is in reply to your letter in which you request a ruling regarding the income of an S corporation and compensation paid to the sole shareholder.

FACTS

As a Virginia resident, the Taxpayer is the sole shareholder and employee of an S corporation (SC). SC is the exclusive sales agent for territory in Virginia for an unrelated third party. The Taxpayer performs the solicitation and sales function for the SC. When sales are made, SC submits the order to the unrelated third party who processes the orders, bills and collects for the product, pays commissions to SC, and handles the installation and servicing of its product.

In 2007, the Taxpayer plans to move to * (State A). The Taxpayer requests a ruling as to whether the income from SC and salaries paid to the Taxpayer will be considered Virginia source income.

RULING

Nexus

Public Law (P.L.) 86-272, codified at 15 U.S.C. § 381-384, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sales of tangible personal property. The Department limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr. Co. , 505 U.S. 214 (1992). The Department also applies P.L. 86-272 to the solicitation of sales of services. See Public Document (P.D.) 93-75 (3/17/1993).

It is assumed that when the Taxpayer moves to State A, SC will also change its state of commercial domicile and will no longer have an office in Virginia. The Taxpayer, as SC's employee, would travel from State A to Virginia as needed to solicit and administer sales on behalf of the unrelated third-party to its customers.

SC does not sell tangible personal property but provides sales and solicitation services to an unrelated third-party. SC is essentially selling services. As such, these activities clearly serve a business function for SC separate from solicitation. When such activities are conducted in Virginia, they would exceed the protection afforded under P.L. 86-272. Further, based on the information provided, the nature, continuity, frequency, and regularity of the services performed by SC's employee in Virginia, as compared with services performed elsewhere lead to the conclusion that SC's Virginia activities would not de minimis . Accordingly, SC would have nexus with Virginia for income tax purposes.

S Corporation Income

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 federal adjusted gross income (FAGI). See P.D. 88-165 (6/29/1988).

Further, Va. Code § 58.1-325 B, which governs the taxation of income of nonresident individuals such as the Taxpayer, states:

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.

Title 23 VAC 10-110-180 B further states that the income or loss to be included is that amount attributable to a business, trade, profession or occupation carried on in Virginia. Accordingly, 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 an individual's Virginia taxable income. As such, Virginia source income received from an S corporation will remain income from Virginia sources in the hands of the shareholders whether they are residents of Virginia or not.

In this case, SC would be operating both in Virginia and State A and would be required to apportion its income by the standard apportionment method prescribed under Va. Code §§ 58.1-407 through 58.1-416. It should be noted that if the Taxpayer uses property owned by SC in Virginia, such property would be reported in the property factor in accordance with the regulations for movable tangible personal property under Title 23 of the Virginia Administrative Code (VAC) 10-120-170 D. In additions, commissions earned by SC would be reported in the sales factor based on "cost of performance." See Va. Code § 58.1-416 and Title 23 VAC 10-120-230.

Nonresident Salaries and Wages

Pursuant to Va. Code § 58.1-341, a nonresident individual who has income from carrying on a business, trade, profession, or occupation within Virginia is required to file a Virginia individual income tax return, unless the individual meets the "$3,000 filing exception" set forth in Va. Code § 58.1-321. The Virginia taxable income of a nonresident is computed by multiplying his Virginia taxable income (computed as if he were a resident) by the ratio of his net income, gain, loss, and deductions from Virginia sources to his net income, gain, loss, and deduction from all sources.

For salaries and wages from an employer, the "net income, gain, loss, and deductions from Virginia sources" would be an amount equal to (1) the total annual salary from the employer, (2) multiplied by the number of days or portion thereof that the nonresident individual spent in Virginia performing duties for their employer, and (3) divided by the number of days or portion thereof spent anywhere performing duties for the employer. See P.D. 84-90 (7/3/1984).

The Taxpayer did not state how he was compensated by the S Corporation. If the S Corporation pays him a salary, he would need to attribute the salary between State A and Virginia in accordance with P.D. 84-90.

This ruling is based on the facts presented as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia and regulation sections and public documents cited, along with other reference documents, are available online at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions regarding this response, please contact ** in the Department's Office of Policy and Administration, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-1227900669B