Did federal protection for multistate vessel pilots prevent Virginia tax on a nonresident pilot's partnership income from work in Virginia waters?

Subject

Taxability of nonresident income from piloting vessels in Virginia waters.

Plain-English summary

Virginia required the nonresident marine pilot to report and pay tax on the share of partnership income sourced to piloting activity in Virginia waters. The pilot belonged to another state's pilot association, which contracted with shipping lines and filed a federal partnership return. His Chesapeake Bay route regularly entered Virginia waters.

Federal law protected compensation earned by a qualifying multistate vessel pilot from income tax in a state other than the pilot's residence. The dispute was whether the association's pass-through amount was compensation.

The association reported pilot fees minus operating expenses as partnership ordinary income. Under federal and Virginia pass-through rules, the item kept the same character in the pilot's hands. Virginia therefore treated it as ordinary partnership income rather than protected compensation.

Because the association operated in Virginia and the pilot carried on his profession in Virginia waters, Virginia required him to file nonresident individual returns for Virginia-source income. The association also had to file a Virginia pass-through entity return reporting Virginia-source amounts allocated to nonresident partners.

What this means for you

• Federal pilot protection in this ruling turned on whether the income was compensation.
• Partnership reporting and character carried through to the individual partner.
• A nonresident can owe Virginia tax on business or professional income earned in Virginia waters.
• The pass-through entity may have its own Virginia filing obligation for nonresident owners.

Common questions

Did Virginia say the federal pilot statute never applies?

No. It held that the income at issue was ordinary partnership income, not compensation protected by that statute.

Was the pilot's state of domicile disputed?

No. The ruling treated him as a resident of State B and addressed only Virginia-source income.

Citations and references

• 46 U.S.C. §§ 11108(b)(2)(A) and 7101.
• Va. Code §§ 58.1-301, 58.1-302, 58.1-321, 58.1-325, 58.1-341, and 58.1-391(B).
• IRC §§ 61(a)(1), 61(a)(13), and 702(b).
• Treas. Reg. §§ 1.61-2(a)(1) and 1.61-13(a).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-12

Original ruling text

January 21, 2011

Re: Request for Ruling: Individual Income Tax

Dear *:

This will reply to your letter in which you request a ruling concerning the taxability of your nonresident income from piloting vessels in Virginia waters. I apologize for the delay in the Department's response.

FACTS

The Taxpayer is a marine pilot licensed in the state of * (State A). The Taxpayer's domicile is the state of *** (State B). While piloting vessels in the Chesapeake Bay, the Taxpayer's route regularly brings him into Virginia waters where a pilot from the Virginia Pilot Association takes over.

States generally require ships navigating through their waters to have a state­licensed pilot on board. For liability reasons, marine pilots have organized themselves in state-based associations. Shipping lines, or their agents, contract directly with state associations to employ a state-licensed pilot for vessels moving through its waters. The Taxpayer is a member of State A's association.

For federal income tax purposes, State A's association files a partnership return. Each pilot in the association is treated as a partner and receives a share of the association's ordinary income. Historically, Virginia has required marine pilots to pay income tax on the portion of income earned while in Virginia waters. The Taxpayer filed Virginia nonresident returns and paid Virginia income tax in previous taxable years through 2007.

The Taxpayer believes that, under federal law, he is subject to tax on all of his marine piloting income in his state of residence, State B. The Taxpayer requests a ruling regarding whether he, as a resident of State B, is subject to income tax in Virginia with respect to compensation earned from piloting in Virginia waters.

RULING

Under 46 U.S.C. § 11108 (b)(2)(A), an individual "engaged on a vessel to perform assigned duties in more than one state as a pilot" licensed under 46 U.S.C § 7101 is not subject to the income tax laws of a state other than the state in which the individual resides with regard to compensation received for the performance of his piloting duties. The issue for Virginia income tax purposes is whether the income passed through on State A's association partnership return is compensation.

Virginia's conformity to federal law is set forth in Va. Code § 58.1-301, which provides that the terms used in the Virginia income tax statutes will have the same meanings as used in the IRC unless a different meaning is required. As such, Virginia's conformity to federal law is limited to the actual use of a specific term in a Virginia statute. Further, conformity does not extend to terms, concepts, or principles specifically provided for in Title 58.1 of the Code of Virginia .

Because the term "compensation" is not defined in Title 58.1 of the Code of Virginia , the Department would look to the IRC in determining how a particular item would be treated for Virginia income tax purposes. Under IRC § 61(a)(1), "compensation for services" is included in a taxpayer's gross income. Compensation for services is further explained in Treas. Reg. §1.61-2(a)(1) to include:

Wages, salaries, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, bonuses (including Christmas bonuses), termination or severance pay, rewards, jury fees, marriage fees and other contributions received by a clergyman for services, pay of persons in the military or naval forces of the United States, retired pay of employees, pensions, and retirement allowances are income to the recipients unless excluded by law.

Gross income under IRC § 61(a)(13) also includes a taxpayer's distributive share of partnership gross income. Generally, a partner's distributive share of partnership gross income is determined under IRC § 702. See Treas. Reg. §1.61-13(a).

In this case, State A's association reported the fees earned by its pilots less operating expenses as ordinary income on the federal partnership return. Virginia generally conforms to the federal treatment of partnerships. See Va. Code § 58.1-301. A partnership, as such, is not subject to income tax. Any income tax arising from the income of the partnership is the liability of the partners.

Under IRC § 702(b), "The character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share . . . shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership." 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. This would include an association treated as a partnership. State A's association reported the fees as ordinary income, not compensation. As such, the income passed through to the Taxpayer would be considered to be ordinary income and not compensation.

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." Virginia Code § 58.1-341 requires every nonresident individual having Virginia taxable income to file an income tax return.

In this case, State A's association operates in Virginia. Further, the income passed through from State A's association was properly reported as ordinary income on its federal income tax return. Pursuant to Va. Code § 58.1-391 B, the character of that income passed through to the Taxpayer would be the same treatment by State A's association. Based on the facts as presented, the Taxpayer is required to file Virginia nonresident individual income tax returns to report his income from Virginia sources and pay the tax liability on such income. Further, State A's association is required to file a Virginia pass-through entity return in order to report the amount of its Virginia source income passed through to its nonresident partners.

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

The Code of Virginia sections 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 ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Linda D. Foster

Deputy Tax Commissioner

AR/1-3829616895.o