06-4 | Virginia Tax

Tax Type

Individual Income Tax

Description

Taxpayer contends income earned by the Corporation should be allocated to State A

Topic

Computation of Income

Persons Subject to Tax

Date Issued

01-06-2006

January 6, 2006

Re: § 58.1-1821 Application: Individual Income Tax

Dear *****:

This will reply to your letter in which you seek correction of the individual income tax assessments issued to ***** (the "Taxpayers") for the 2002 and 2003 taxable years.

FACTS

The Taxpayers, a husband and wife, were residents of ***** ("State A"). They moved to Virginia in July 2003 and filed a part-year Virginia individual income tax return for 2003.

The husband was the sole shareholder of a State A Subchapter S corporation (the "Corporation") that had a client in Virginia. Prior to moving to Virginia, the husband traveled to Virginia to perform work at the client's facility.

Under audit, the Department determined that the Corporation had nexus with Virginia. When the Taxpayers failed to provide Virginia income tax returns for the Corporation, the Department attributed all the Corporation's income to Virginia and assessed the Taxpayers as nonresidents for the 2002 and 2003 taxable years.

The Taxpayers appeal the assessments and contend that all the income earned by the Corporation should be allocated to State A until July 2003. They also contend that the Department did not credit an extension payment that they included with their 2003 part-year return.

DETERMINATION

S Corporation

Virginia generally conforms to the federal treatment of S corporations. Electing small business corporations that make the election under Subchapter S of the Internal Revenue Code to have the income of the corporation included in the income of the shareholders are exempt from the Virginia corporate income tax. Such corporations are required to file a Virginia return even though exempt from income tax. See Public Document ("P.D.") 88-165 (6/29/88).

Public Law ("P.L.") 86-272, codified at 15 U.S.C. § 381-384, prohibits a state from imposing a net income tax where the only contacts with a state are a narrowly defined set of activities constituting solicitation of orders for sales of tangible personal property. In this situation, the husband is engaged in the sale of services, which are clearly outside the federal statutory protection of P.L. 86-272. The Department, however, applies P.L. 86-272 to the solicitation of sales of other than tangible personal property. See P.D. 93-75 (3/17/93).

The Department's policy is to extend the "solicitation test" of P.L. 86-272 to situations involving the sale of intangible personal property. The Department, however, limits the scope of P.L. 86-272 to only those activities that constitute solicitation, are ancillary to solicitation, or are de minimis in nature. See Wisconsin Department of Revenue v. William Wrigley, Jr. Co., 505 U.S. 214 (1992).

The husband indicates that he provided, on behalf of the Corporation, financial and consulting services over a period of several years within Virginia. Such services exceed the mere solicitation of sales and clearly were not de minimis in nature. As such, the Corporation had nexus with Virginia.

Corporations (including S corporations) that have nexus with Virginia and income from business both within and without Virginia must compute their Virginia source income in accordance with the corporate statutory formula set forth in Va. Code §§ 58.1-408 through 58.1-421. Therefore, such S corporations must allocate dividends to the state of commercial domicile and apportion all other income. Virginia's standard method of apportionment uses a three-factor formula based on the property, payroll and sales within Virginia.

In this case, the Corporation sells financial services. As such, it may qualify for a special method of apportionment under Va. Code § 58.1-418. Under this method, the income is apportioned in the ratio that the business within Virginia is to the total business of the corporation.

Based on the information presented, the Corporation operated both in Virginia and State A. Therefore, the Corporation must file income tax returns for the 2002 and 2003 taxable years to show the amount of income apportioned to Virginia.

Nonresident Returns

A nonresident shareholder of an S Corporation having Virginia taxable income is required by Va. Code § 58.1-341 to file an individual income tax return unless his federal adjusted gross income, adjusted by specific Virginia modifications, is below the filing thresholds of Va. Code § 58.1 321. The Virginia taxable income of a nonresident individual, partner, shareholder or beneficiary is Virginia taxable income computed as a resident multiplied by the ratio of net income, gain, loss and deductions from Virginia sources to net income, gain, loss and deductions from all sources.

Therefore, unless the Corporation has an apportionment factor of zero for the 2002 taxable year, the husband will need to file a nonresident individual income tax return for the 2002 taxable year. The return must include the allocated and apportioned income generated by the Corporation.

Actual Resident

Two classes of residents, a domiciliary resident and an actual resident, are set forth in Va. Code § 58.1-302. The domiciliary residence of a person means the permanent place of residence of an individual or the place to which he intends to return even though he may actually reside elsewhere. For an individual to change his domiciliary residency to another state, that individual must intend to abandon his state of domicile with no intention of returning to that state. Concurrently, that individual must acquire a new domicile, where that individual is physically present with the intention to remain there permanently or indefinitely. An actual resident of Virginia means an individual who, for an aggregate of more than 183 days of the taxable year, maintains a place of abode within Virginia, whether domiciled in Virginia or not.

The husband stated that he spent approximately 250 days in Virginia during 2003. As such, even though he did not move to Virginia until July 2003, he was an actual resident of Virginia for the 2003 taxable year. Accordingly, the husband must file a Virginia resident individual income tax return for the 2003 taxable year. As an actual resident, all of the husband's income from the Corporation would be subject to Virginia income tax. The husband would, however, be entitled to a credit for tax paid to another state pursuant to Va. Code § 58.1-332.

Extension Payment

The Taxpayers contend that they made a payment with the extension filed for the 2003 part-year return. The Department's records do not show receipt of this payment. Without proof of payment, the assessment for the 2003 part-year return must be upheld.

CONCLUSION

The Corporation must file a Virginia Form 500 S for the 2002 and 2003 taxable years. In addition, the Taxpayers must file a Virginia Form 763 nonresident individual income tax return for the 2002 taxable year and a Form 760 resident individual income tax return for the husband for the 2003 taxable year. As a result, the 760 part-year return for 2003 may need to be amended.

All returns, plus proof of the extension payment, should be sent to ***** Senior Tax Auditor, Office of Compliance, RAP Unit, Virginia Department of Taxation, P.O. Box 27003, Richmond, Virginia 23261-7003, within 30 days from the date of this letter. If the returns and extension documentation are not provided, the assessments will be correct as issued and collection actions will resume.

The Code of Virginia sections, regulation, and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have any questions regarding this determination, you may
contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.

- - - - Sincerely,

- - - - Kenneth W. Thorson
        Tax Commissioner

AR/54970B

Rulings of the Tax Commissioner