Could nonresident grantor trusts, QSSTs, and ESBTs join an S corporation's Virginia composite return?

Plain-English summary

Virginia allowed an S corporation to include qualifying nonresident grantor trusts, qualified Subchapter S trusts, and electing small business trusts in a composite or unified nonresident return.

Grantor trusts could participate when the grantor was treated as the federal owner and the trust qualified as an S-corporation shareholder. QSSTs were treated as grantor trusts and could also participate. ESBTs could participate if they satisfied IRC § 1361(e) and Treas. Reg. § 1.1361(m).

The ruling did not waive classification or filing requirements; each trust had to qualify and the composite return had to meet Virginia's rules.

Citations and references

• Va. Code §§ 58.1-301, 58.1-401, 58.1-395, and 58.1-390.1
• IRC §§ 671, 676, and 1361(c), (d), and (e)
• Treas. Reg. § 1.1361(m)
• 23 VAC 10-120-90 E
• P.D. 88-165 and P.D. 07-99

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-71

Original ruling text

May 2, 2018

Re: Ruling Request: Corporate Income Tax

Dear *:

This will reply to your letter in which you request a ruling on behalf of your client, * (the “Taxpayer”), regarding whether grantor trusts, qualified subchapter S trusts, and electing small business trusts may be included in a composite nonresident individual income tax return. I apologize for the delay in responding to your request.

FACTS

The Taxpayer is an S corporation for federal income tax purposes. Its shareholders include grantor trusts, qualified Subchapter S trusts (QSSTs), and electing small business trusts (ESBTs) that qualify as nonresident trusts in Virginia. The Taxpayer seeks a ruling that these grantor trusts, QSSTs and ESBTs may be included in a composite nonresident income tax return.

RULING

S Corporations

Virginia's conformity to federal income tax law is set forth in Virginia Code § 58.1­-301, which provides that the terms used in the Virginia income tax statutes will have the same meaning as used in the Internal Revenue Code (IRC). Further conformity does not extend to terms, concepts, or principles specifically provided for in Title 58.1 of the Code of Virginia . For Virginia, federal taxable income (FTI) and federal adjusted gross income (FAGI), the starting points for determining income taxable in Virginia for corporations and individuals, respectively, are identical to that as defined by the IRC.

In following federal tax policy with respect to S corporations, Virginia Code § 58.1-401 provides that such corporations are not subject to income tax in Virginia. Thus, Virginia has elected to treat S corporations in substantially the same manner as has the Internal Revenue Service (IRS), i.e ., the corporate entity itself is not subject to taxation, but the shareholders will be taxed as individuals on their pro rata share of S corporation income to the extent includable in FAGI. See Title 23 of the Virginia Administrative Code (VAC) 10-120-90 E, Public Document (P.D.) 88-165 (6/29/1988) and P.D. 07-99 (6/27/2007). As such, the Taxpayer's items of income, gain, loss, deduction and credit flow through to its shareholders.

Composite or Unified Returns

Virginia Code § 58.1-395 allows pass-through entitles to make a written application to the Department for permission to file a statement of combined pass-through entity income attributable to nonresident owners in lieu of each owner filing a nonresident income tax return. An owner is “any individual or entity who is treated as a partner, member, or shareholder of a pass-through entity for federal income tax purposes.” See Virginia Code § 58.1-390.1. As such, an entity other than an individual may file as part of a composite return depending on its classification.

Grantor Trusts

Grantor trusts are disregarded entities for federal income tax purposes. Under the grantor trust rules, a person (the grantor) who transfers property to a trust and retains certain powers or interests is treated as the owner of the trust for income tax purposes. As a result, the income and deductions attributable to the trust are reported by the grantor on his income tax return. See IRC § 671. If the grantor retains the ability to revoke the trust and re-vest title to trust property in the grantor, the grantor is considered the owner of the trust. See IRC § 676. Grantor trusts qualify as S corporation shareholders provided that the grantor is deemed to own the entire trust for federal income tax purposes and the owner is a citizen or resident of the United States. See IRC § 1361(c)(2)(A)(i). Under these circumstances, the Department will permit grantor trusts to be included in a unified return.

Qualified Subchapter S Trusts

Pursuant to IRC § 1361(d)(3)(A), a QSST is a trust in which: (1) there is only one income beneficiary of such trust who is a citizen or resident of the United States; (2) the corpus of the trust can only be distributed to such beneficiary; (3) the beneficiary's interest in the trust terminates upon the earlier of the termination of the trust or the death of the beneficiary; and (4) the trust must distribute all of its assets to the beneficiary upon its termination. QSSTs are treated as grantor trusts. See IRC § 1361(d)(1)(A). As such, QSSTs may be included in a Virginia unified return of an S corporation.

Electing Small Business Trusts

Under IRC § 1361(e), a trust that holds S Corporation stock may elect treatment as an ESBT if:

such trust does not have as a beneficiary any person other than an individual, an estate, an organization described in IRC § 170(c), or (IV) an organization described in IRC § 170(c)(1) which holds a contingent interest in such trust and is not a potential current beneficiary,

no interest in such trust was acquired by purchase, and

an election under IRC § 1361(e) applies to such trust.

In addition, an ESBT must meet all of the requirements set forth in Treas. Reg. § 1.1361(m). If all the requirements are met, ESBTs may file as part of a Virginia unified return.

CONCLUSION

In accordance with this ruling, qualifying grantor trusts, QSSTs, and ESBTs may be included in a Virginia nonresident composite trust provided the filing requirements are met.

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

The Code of Virginia sections, regulation, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & 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/1072.B