Did a nonresident limited partner owe Virginia tax on income from a Virginia family partnership holding land and tangible assets?

Subject

VLP is headquartered in Virginia and conducts all of its operations in Virginia.

Plain-English summary

Virginia upheld tax on the nonresident partner's share of the Virginia limited partnership's income. The partnership did not qualify for the Department's passive intangible-investment treatment because it owned Virginia land, tangible coins, and interests in LLCs that owned Virginia land.

Pass-through attributes of the real and tangible property supported Virginia-source treatment. The partnership was headquartered in Virginia, its general partners were Virginia residents, and all operations occurred in Virginia.

Those Virginia contacts also satisfied due process. The partner's limited status did not prevent Virginia from taxing income passed through from an entity availing itself of Virginia law and protections.

What this means for you

• A pass-through holding only intangibles may differ from one holding land or tangible assets.
• Underlying LLC and partnership property attributes can flow through ownership tiers.
• Limited-partner status does not automatically eliminate nonresident tax.
• Headquarters, management, operations, and asset location all matter.

Common questions

Q: Why was the partnership not treated as a passive investment entity?
A: It owned Virginia real and tangible property and interests in land-owning LLCs.

Q: Did due process prevent Virginia tax?
A: No. The partnership was headquartered and operated in Virginia and received Virginia legal protections.

Citations and references

• Va. Code §§ 58.1-325 and 58.1-391 B.
• Virginia Tax Bulletin 05-6 and P.D. 94-275.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-123

Original ruling text

June 26, 2008

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to * (the "Taxpayer") for the 2004 taxable year. I note the assessment has been paid in full.

FACTS

The Taxpayer, a resident of * (State A), held a 13% limited partnership

interest in the * (VLP), a Virginia limited partnership. VLP was formed by the Taxpayer's parents as a family limited partnership to shift wealth to the Taxpayer and her siblings. During the 2004 taxable year, the Taxpayer's father and brother, both Virginia residents, were VLP's general partners. VLP's primarily asset holdings include savings accounts, certificates of deposit, stocks, bonds, a passive overriding royalty interest, and holdings in publicly traded partnerships as a limited partner. VLP also owned two plots of unimproved land located in Virginia and some coins that were kept in a Virginia vault. The coins were held for their metallurgic value, not as collectables.

In addition, VLP held a minority interest in two limited liability companies, * (LLC 1) and *** (LLC 2). Both LLC 1 and LLC 2 owned unimproved tracts of land in Virginia.

The Taxpayer filed a Virginia nonresident individual income tax return but did not report any income generated by VLP as Virginia source income. Upon audit, the Department concluded that all of VLP's income was Virginia source income and issued an assessment. The Taxpayer paid the assessment and filed an administrative appeal contending that the Department improperly classified the income as Virginia source income on her nonresident return. She requests the assessment issued for the 2004 taxable year be abated and a refund issued.

DETERMINATION

Virginia Source Income

Pursuant to Va. Code § 58.1-325, 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 filing exception described 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. Under Va. Code § 58.1-302, "income and deductions from Virginia sources" includes income from "a business, trade, profession or occupation carried on in Virginia."

Income from Virginia sources of a pass-through entity is defined to include income from the ownership of an interest in real or tangible personal property in Virginia or income from intangible personal property. See Title 23 of the Virginia Administrative Code (VAC) 10-110-180 B. Income from intangible personal property includes 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.

The Taxpayer contends that VLP was not engaged in a business, trade, profession or occupation carried on in Virginia. VLP had no employees and no property for conducting a business. Further, she states that the undeveloped land and coins owned by VLP were not employed in a business, trade, profession or occupation carried on in Virginia because they did not generate any income. The Taxpayer, therefore, asserts that the income generated from the intangibles was not Virginia source income because it did not come from property employed by the Taxpayer in a business, trade, profession or occupation carried on in Virginia.

The Taxpayer further cites Public Document (P.D.) 94-275 (9/16/1994) to support her position. Tax Bulletin (VTB) 05-6 (5/6/2005) reiterates and clarifies the Department's policy established in P.D. 94-275. VTB 05-6 provides that pass-through entities that are established solely to invest in intangible personal property, such as stocks and bonds, and that have no employees, and no real or tangible property are not considered to be carrying on a trade or business. VLP, however, owned land, tangible assets and a minority interest in two limited liability companies that own land in Virginia. VLP, therefore, did not qualify as an investment pass-through for Virginia income tax purposes.

Under Treas. Reg. § 301.7701-2(c)(1), a "partnership means a business entity that is not a corporation under paragraph (b) of this section and that has at least two members." Virginia generally conforms to the federal treatment of pass-through entities. Each item of pass-through entity income, gain, loss or deduction has the same character for an owner for Virginia income tax purposes as for federal income tax purposes. See Va. Code § 58.1-391 B. Thus, with the exception of those partnerships that meet the requirements of VTB 05-6, all other partnerships must be presumed to be operating as a trade or business.

During the 2004 taxable year, VLP was a limited partnership located in and operating in Virginia. VLP received income from its various investments. No evidence has been provided to indicate that VLP operated in any state other than Virginia. Accordingly, all of VLP's income resulted from a business, trade, profession or occupation carried on in Virginia for the taxable year at issue.

Due Process

The Taxpayer cites the Due Process Clause of the U. S. Constitution in support of the position that the Taxpayer's income from VLP is taxable by Virginia. The operation of the Due Process Clause as a limitation on the taxing power of the states usually involves one of two basic issues: (1) the relationship between the state exercising taxing power and the object of that exercise of power, and (2) whether the degree of contact is sufficient to justify the state's imposition of a particular obligation.

The Taxpayer contends that she lacks sufficient contacts with Virginia for the Department to impose an income tax on her. She states that she has not availed herself of the protections of Virginia because she is merely a limited partner in a partnership that owns undeveloped real property and non-income producing tangible property in Virginia.

In this case, VLP is headquartered in Virginia and conducts all of its operations in Virginia. There is no question that VLP availed itself of the rights and protections afforded by the laws of the Commonwealth. Accordingly, the Department is well within its jurisdictional rights to impose tax on the income of VLP.

VLP, however, is treated as a partnership for federal income tax purposes. Because VLP was not treated as a separate taxable entity for federal taxation purposes, it is not considered to have had any federal taxable income (FTI), the starting point for computing the income tax of a corporation. As such, although VLP conducted its legal existence and business activities in Virginia, it had no FTI for computing a Virginia taxable income.

The construction of the federal and Virginia tax statutes allows partners to pay income tax on behalf of the partnership. It follows then that, because items of income, gain, loss or deduction retain their character as they pass-through to a taxable entity, the attributes and activities of a partnership that make it subject to Virginia tax inure with such items as they are passed through to the partners. It is not a matter of whether the income is subject to tax, but who is paying the tax. In the case of a nonresident partner, the Department is merely exerting its authority to tax the income of partnership operating within its jurisdiction. Thus, the Department's assessment of additional tax against the Taxpayer is permissible under the Due Process Clause.

CONCLUSION

Based on the foregoing, the Department's assessment issued to the Taxpayer for the 2004 taxable year is correct. Accordingly, the Taxpayer's request for refund is denied.

The Code of Virginia sections, Tax Bulletin and public document cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2052509316.B