Must a Virginia partnership withhold for nonresident partners on guaranteed payments for services performed outside Virginia?

Subject

Nonresident Withholding on Guaranteed Payments

Plain-English summary

Virginia ruled that a partnership does not have to withhold Virginia tax from a nonresident partner's guaranteed payments when the payments are not Virginia-source income and therefore are not taxable by Virginia.

The partnership's nonresident partners generally performed services in their home states, and their guaranteed payments were made without regard to partnership profit. The Department treated those payments more like compensation than a share of the partnership's trade or business income. If the payments were not Virginia-source income, the nonresident withholding statute did not apply.

The request also mentioned salaries and bonuses, but the published operative analysis and conclusion address guaranteed payments. The ruling does not separately decide the withholding treatment of the other payment categories.

What this means for you

Pass-through entities should determine the source of each nonresident partner payment rather than assume every guaranteed payment follows the partnership's Virginia business income. The result remains conditional on the payment not being Virginia-source income.

Citations and references

• Va. Code § 58.1-301 — Virginia conformity to federal terminology.
• IRC §§ 61, 162, 263, and 707 — federal guaranteed-payment treatment discussed in the ruling.
• Va. Code § 58.1-486.2(A), (B)(1) — withholding on a nonresident owner's Virginia-source income.
• P.D. 05-38 and P.D. 15-240, cited by the Commissioner.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-202

Original ruling text

December 13, 2017

Re: Ruling Request: Nonresident Withholding Tax

Dear *:

This letter is in response to your request for a ruling regarding the applicability of the Virginia withholding requirements for nonresident partners receiving guaranteed payments, salaries and bonuses when such payments, salaries, and bonuses are made without regard to the profit interest of the pass-through entity (PTE). I apologize for the delay in responding to your request.

FACTS

The Taxpayer is a Virginia based partnership with offices located within and outside of Virginia. The Taxpayer has resident and nonresident partners. The nonresident partners generally provide services within their resident state. The Taxpayer requests guidance on Virginia's withholding requirements for nonresident partners who receive salaries, guaranteed payments and bonuses for services provided in their state of residence and such payments are made without regard to the profit or performance of the partnership.

RULING

Guaranteed Payments

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Virginia Code will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Virginia “conforms” to federal law because it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI).

Under Internal Revenue Code (IRC) § 707, guaranteed payments are payments made by a partnership to a partner without regard to partnership income for the use of capital (interest payments) or for services rendered (fixed salaries or minimum payments). The payments are treated as if made to someone who is not a partner when determining gross income under IRC § 61 (a) and deductions permitted under IRC § 162 (a) and 263. This “outsider treatment” allows the partnership to deduct certain business expenses as deductions to the partnership and income to the partner. For other purposes within the IRC, guaranteed payments are treated as a partner's distributive share of ordinary income.

In Public Document (P.D.) 05-38 (3/16/2005), the Department ruled that guaranteed payments made to nonresident partners are treated as ordinary income ( i.e. , payments made to a partner for services or the use of capital) when such payments are made without regard to the profitability of the partnership. Likewise, for Virginia income tax purposes, such guaranteed payments would be treated more similarly to compensation and not income from the partnership's trade or business.

Nonresident Withholding Requirement

Virginia Code § 58.1-486.2 A, provides that “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 withholding tax. The amount of tax that must be withheld is equal to 5% of the nonresident owner's share of income from Virginia sources of all nonresident partners that may lawfully be taxed by Virginia and which is allocable to a nonresident owner. See Virginia Code § 58.1-486.2 B 1 and Public Document (P.D.) 15-240 (12/22/2015).

Exemptions, however, may apply for partners who receive income under treaty agreements; nonresident partners operating as banks, insurance companies, public utility companies organized as a corporations and tax exempt organizations charted under Internal Revenue Code § 501. Individuals who have no Virginia source income in the previous taxable year, and expect no Virginia source income in the current year, may also qualify for an exemption from nonresident withholding.

Based on the facts and circumstance presented in this ruling request, the nonresident partners are receiving guaranteed payments without regard to the profitability of the PTE. If such payments are not considered to be Virginia source income and therefore not subject to Virginia income tax, the guaranteed payments would be exempt from the nonresident withholding requirements under Virginia Code § 58.1-486.2 A.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions 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,

Craig M. Burns

Tax Commissioner

AR/800.o