Did a Virginia pass-through entity have to withhold for two C-corporation members domiciled outside Virginia?

Subject

Taxability of pass-through entities

Plain-English summary

Virginia required the pass-through entity to pay withholding for its C-corporation members if they were commercially domiciled outside Virginia and received allocated Virginia-source taxable income. The 2007 law imposed a 5% tax on nonresident owners' shares of Virginia-source income.

The corporate members did not appear to qualify for the exception for corporations exempt from Virginia income tax because they filed Virginia corporate returns and paid tax. The entity would report each member's allocated withholding on Form VK-1, and the member would claim it with other payments and credits on Form 500.

The members could reduce estimated payments only after considering the withholding credit. If expected liability after credits exceeded $1,000, estimated payments remained required; a balance above $1,000 on the return could trigger penalties.

What this means for you

• Determine each entity owner's commercial domicile and Virginia-source allocation.
• Pass-through withholding can apply to corporate owners, not only individuals.
• Give each nonresident owner the withholding allocation needed to claim its credit.
• Recalculate estimated payments after the PTE withholding credit rather than stopping them automatically.

Common questions

Q: Did filing Virginia corporate returns exempt the members from PTE withholding?
A: No. The ruling treated that fact as evidence they were not exempt from Virginia corporate income tax.

Q: What rate did the 2008 ruling apply?
A: Five percent of the nonresident owners' allocated Virginia-source income.

Q: Could the members stop estimated payments?
A: Only if expected liability after the withholding credit did not exceed the statutory $1,000 threshold.

Citations and references

• Va. Code §§ 58.1-486.2 A and 58.1-500.
• 2007 Va. Acts ch. 796.
• P.D. 07-150.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-147

Original ruling text

July 30, 2008

Re: Ruling Request: Pass-through Entity Withholding Tax

Dear *:

This is in response to your letter in which you requested a ruling regarding whether a pass-through entity (the "PTE") must pay the withholding tax regarding its corporate members for the 2008 calendar year.

FACTS

You state that the PTE has two members, both of which are C corporations. You also inform me that the members have historically remitted quarterly estimated payments to Virginia and filed corporate income tax returns with Virginia. On these returns, the members have reported their shares of pass-through income that were apportioned to them.

You now ask whether the PTE must pay the new withholding tax regarding these corporate members. If so, you ask if the members should discontinue making quarterly estimated payments.

RULING

During the 2007 General Assembly session, Senate Bill 1238 (Chapter 796, 2007 Acts of Assembly) was enacted. This legislation created a new tax to be imposed on pass-through entities. This tax is not applicable to all pass-through entities, however. Instead, under Va. Code § 58.1-486.2 A, "a pass-through entity that has taxable income for the taxable year derived from or connected with Virginia sources, any portion of which is allocable to a nonresident owner" must pay the tax. The tax is equal to five percent of the nonresident owners' shares of income from Virginia sources. The pass-through entity, however, may apply any tax credits allowable under the Code of Virginia that flow through to nonresident owners.

In Public Document ("P.D.") 07-150, "Guidelines for Pass-Through Entity Withholding," the Department of Taxation ("TAX") provided some clarification regarding the term "nonresident owner." For the purposes of the withholding tax, a nonresident owner will be "any [individual or entity] who is treated as a partner, member, or shareholder of the pass-through entity for federal income tax purposes and, in the case of an individual, is not a domiciliary or actual resident of Virginia, or, in the case of any other entity, does not have its commercial domicile in Virginia."

Pass-through entities are not always required to pay the withholding tax, however. The law has provided for certain exceptions, which have been more fully described in P.D. 07-150. For example, pass-through entities that are publicly traded partnerships or disregarded entities are not required to pay any withholding tax. Furthermore, the pass-through entity does not have to pay the tax on behalf of certain specified corporations, entities, and individuals. That list includes corporations that are exempt from the Virginia corporate income tax.

Although the new withholding tax is paid by the pass-through entity, the nonresident owners of the entity will receive a credit for the tax payments when they file a tax return. Pass-through entities will inform nonresident owners how much of the withholding tax was allocated to them on the Form VK-1.

In this specific case, if the C corporation members do not have their commercial domiciles in Virginia, the PTE will be responsible for paying the withholding tax if the PTE has taxable income for the taxable year that is derived from or connected with Virginia sources and at least some of that income is allocated to the C corporation members. It does not appear that the members would fit the exception for corporations that are exempt from Virginia income tax because you state that they do file Virginia corporate income tax returns and pay income taxes.

Any withholding tax required to be paid by the PTE would be allocated to the corporate members on the Form VK-1; and the members would report such allocations when they filed their corporate income tax returns. The withholding tax would be included with the other payments and credits reported on the Form 500.

Regarding the estimated payments, under Va. Code § 58.1-500, it is the responsibility of the corporate member to ensure that estimated payments are made if the income tax liability, "reduced by any credits allowable against the tax, can reasonably be expected to exceed $1,000." The withholding tax paid by the PTE and allocated to the members will count as a credit for the purposes of determining whether the income tax liability will exceed $1,000. Therefore, if the member's tax liability will be less than $1,000 after taking the withholding tax allocation into account, the corporate member will not be required to make estimated tax payments. Please note, however, that if the income tax liability due with the member's corporate income tax return exceeds $1,000, the applicable penalties will apply.

I trust that this reply answers your ruling request. The Code of Virginia sections cited and other reference documents are available on-line in the Tax Policy Library section of the TAX's web site located at www.tax.virginia.gov. If you should have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Policy Development, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner