Tax Bulletins

Previous Filing Requirements for Pass-Through Entities

Under the law, prior to January 1, 2004, S corporations were required to file Virginia Form 500S, estates and trusts were required to file Virginia Form 770, and other types of pass-through entities organized under the laws of the Commonwealth or having income from Virginia sources were not required to file a report with the Department.

New Filing Requirements

Effective for taxable years beginning on or after January 1, 2004, pass-through entities doing business in Virginia or having income from Virginia sources are required to make a return to the Department on or before the fifteenth day of the fourth month following the close of its taxable year. The Department has developed Form 502, Pass-Through Entity Return of Income, for this purpose. Estates and trusts will continue to file Form 770, but all other pass-through entities (including S corporations) will file Form 502. Use of Form 500S for S corporations will be discontinued.

Investment Pass-Through Entities

Previous rulings have held that pass-through entities that are established solely to invest in intangible personal property, such as stocks and bonds, and that have no employees, and no real or tangible property (hereafter referred to as “investment pass-through entities”) are not considered to be carrying on a trade or business. See Public Documents (P.D.) 94-275 (9/16/94), 95-280 (11/3/95), and 96-42 (4/10/96). Thus, the income from the intangible property held by an investment pass-through entity is not income from Virginia sources, and these types of pass-through entities will not be required to file the new Form 502.

The person who manages the investments of such a pass-through entity will be subject to taxation in Virginia if the manager carries on any business in Virginia and will be required to file the appropriate return. The fact that the manager of an investment pass-through entity is located in Virginia will not cause the income of the investment pass-through entity to be considered income from Virginia sources, whether the manager is one of the owners of the investment pass-through entity or an unrelated party.

The income, deductions and other attributes of an investment pass-through entity will pass through to its owners and be included in the federal adjusted gross income or federal taxable income of each individual or corporate owner. The impact of such income on the Virginia tax liability of the owner is as follows:

• Residents: Individuals who are residents of Virginia will file a Form 760 reporting their federal adjusted gross income. Any income from an investment pass-through entity that is included in federal adjusted gross income will not be considered income derived from another state based solely on the fact that the state in which the investment PTE is organized or managed is other than Virginia.
  
  Nonresidents: Individuals who are not residents of Virginia will not be required to file a nonresident Virginia income tax return solely because of income from an investment pass-through entity. If they have other income from Virginia sources requiring the filing of a nonresident income tax return, the income derived from an investment pass-through entity will not be considered income from Virginia sources even if the an investment pass-through entity is organized under Virginia law or managed by a person located in Virginia.
  
  Corporations:
  
  • Nexus: Corporations will not be required to file a Virginia income tax return solely because of income from an investment pass-through entity. If a corporation has other income from Virginia sources requiring the filing of a Virginia income tax return, the income derived from such a pass-through entity will not be considered gross receipts attributable to Virginia for purposes of the sales factor solely because an unrelated party located in Virginia is managing the intangible assets of the investment pass-through entity or otherwise conducting income-producing activity on behalf of the investment pass-through entity.
    
    Apportionment Factors: In general, corporations that are limited partners do not include their shares of partnership property, payroll and sales in the numerator or denominator for purposes of determining their Virginia apportionment factors. Under P.D. 95-19 (2/13/95), however, when the limited partner and the general partner are related parties and the affiliated group holds a substantial amount of the partnership interests, the limited partner may be required to include its proportionate share of the limited partnership’s property, payroll and sales for purposes of determining its Virginia apportionment factor.
    
    Apportionable Income: Under Virginia law, all income of a multistate corporation, other than dividends, is generally apportionable. Corporations may request an alternative method of allocation and apportionment in which certain investment function income is allocable to specific states. This requires a facts and circumstances analysis and general rules cannot be provided. The relationship between the corporate owner and the manager of the investment pass-through entity would be one of many relevant factors in the determination as to whether an alternative method will be allowed as well as whether an adjustment to taxable income is required under Va. Code §§ 58.1-445 or 58.1-446.
    
    Royalty addback: If the intangible assets of the investment pass-through entity consist of patents, copyrights, trademarks and similar assets, any royalties or other payments by a corporate owner or its affiliated entities to the investment pass-through entity with respect to such assets may be subject to the addback requirements of Va. Code § 58.1-402 C (8).