Did a federally exempt governmental investment board owe Virginia income tax or pass-through filing through its real-estate LLCs?

Subject

Board is exempt from federal taxation under IRC § 501(a) and is not required to file to federal income tax return

Plain-English summary

Virginia ruled that income from the board's Virginia real-estate LLCs would not be subject to corporate income tax if each LLC met the requirements stated in IRS PLR 200243023. The board was a governmental instrumentality, federally exempt under IRC § 501(a), and its essential-governmental-function income was excluded from federal gross income under IRC § 115(1).

Because Virginia conformed to federal taxable income, qualifying LLC income excluded from the board's federal taxable income would also be outside the Virginia corporate-income-tax base.

The LLCs also would not have to file Virginia pass-through entity returns. Virginia's definition required owners to report their shares of entity income, gains, losses, deductions, and credits on federal returns. The exempt board did not file a federal income-tax return, so its LLCs were not treated as pass-through entities for that filing requirement.

What this means for you

• The result depended on the board's federal exemption and the LLCs satisfying the cited IRS ruling's requirements.
• Virginia began with federal taxable income under its conformity statute.
• A single-member LLC's Virginia pass-through filing duty depended on whether its owner reported entity items on a federal return.
• Changes in ownership, function, private benefit, federal status, or LLC activity could change the result.

Common questions

Q: Was every government-owned LLC automatically exempt?
A: No. The ruling was conditional on each LLC meeting the requirements described in IRS PLR 200243023.

Q: Why was the LLC income outside Virginia tax?
A: Qualifying income was excluded from the board's federal taxable income, and Virginia conformed to that federal starting point.

Q: Why were no Virginia pass-through returns required?
A: The exempt board did not report LLC items on a federal income-tax return, so the LLCs did not meet the cited Virginia pass-through definition.

Citations and references

• Va. Code §§ 58.1-301, 58.1-390.1, and 58.1-392.
• IRC §§ 115(1) and 501(a).
• IRS Rev. Rul. 90-74 and PLR 200243023 (Oct. 25, 2002).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-138

Original ruling text

July 30, 2008

Re: Ruling Request: Corporate Income Tax

Dear *:

This is in response to your letter dated May 14, 2008, in which you request a ruling concerning the application of Virginia's corporate income tax to activities conducted by your client, the * (the "Board"). The Board conducts activities in Virginia through five single-member limited liability companies: , , , and *** (collectively, the "LLCs").

FACTS

The Board is an instrumentality of the * created for the purpose of providing professional investment management of various trusts and operating funds established under the laws of . The Board operates as a trust forming part of a pension, profit-sharing, or stock bonus plan qualified under Internal Revenue Code (IRC) § 401(c) that is exempt from federal income taxation under IRC § 501(a). The Internal Revenue Service (IRS) has further determined that income earned by the Board is exempt because it is derived in the exercise of an essential governmental function and accrues to **. As such, the Board has never filed a federal income tax return.

The Board formed the LLCs for the sole purpose of holding real estate assets located in Virginia in order to shield the Board's other investments from any liabilities associated with owning and operating the real estate assets. The Board requests that the Department rule that the income from the LLCs is not subject to Virginia corporate income tax because the income is derived from an essential governmental function of

RULING

Virginia's conformity to federal law is set forth in Va. Code § 58.1-301. This section states that, except as otherwise provided, the terms used in the Virginia income tax statutes will have the same meanings as used in the IRC. Therefore, federal taxable income (FTI) for corporations is identical to that as defined by the IRC.

Under IRC § 115(1), gross income does not include income derived from the exercise of any essential governmental function and accruing to a state or political subdivision. According to IRS Revenue Ruling (Rev. Rul.) 90-74, income earned by an organization formed, operated and funded by more than one political subdivision for the purpose of providing an essential governmental function is excluded from gross income under IRC § 115(1) provided that private interests do not participate in the organization or benefit more than incidentally from the organization.

The Board requested and received a private letter ruling (PLR) from the IRS. In PLR 200243023 (10/25/2002), the IRS concluded that the income of one of the Board's limited liability companies is excludable from gross income under IRC §115. As such, provided that all the LLCs in Virginia meet the requirements specified in PLR 200243023, their income would not be included in the Board's FTI and would not be subject to income tax in Virginia.

Further, the LLCs would not be required to file Virginia pass-through entity returns as required by Va. Code § 58.1-392. In order to be a pass-though entity subject to Virginia's filing requirement, the owners of a pass-through entity must report their share of income, gains, losses, deductions and credits from the entity on their federal income tax returns. See Va. Code § 58.1-390.1. Because the Board is exempt from federal taxation under IRC § 501(a) and is not required to file to federal income tax return, the LLCs would not be considered pass-through entities for purposes of filing pass-through entity returns.

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

The Code of Virginia sections cited and other reference documents 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 ruling, you may contact * in the Office

of Tax Policy, Appeals and Rulings, at *.

Sincerely,

Janie E. Bowen

Tax Commissioner

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