Virginia Clarifies Changes to Long-Standing Apportionment Policy Following Court Case

The Virginia Department of Taxation has released Tax Bulletin 25-5 to explain the impact a recent appellate decision will have on apportionment for corporations with ownership in pass-through entities (PTEs). 

The Department has long required aggregate apportionment for corporate income tax purposes when a corporation is an owner of a PTE. The aggregate formula combines the corporate owner’s share of the PTE’s apportionment factors with the corporation’s own factors. That formula is then applied to the corporation’s total apportionable income, including the corporation’s share of the PTE’s apportionable income.

However, in FJ Mgmt. Inc. v. Dep’t of Tax’n, No. 0701-23-2 (Va. App. Ct. 2024), the Virginia Court of Appeals held that corporations that own PTEs and use blended apportionment factors are in violation of the U.S. Constitution if the entities do not have a unitary business relationship. Instead, the amount of the non-unitary PTE’s income a corporate partner is to be taxed on is its distributive share of that income apportioned to Virginia at the PTE-level based on the PTE’s apportionment factors.

In response to the case, the Department issued Tax Bulletin 25-5 to update its position when there is no unitary relationship: 

• Include on Form 500A, Line 3(b), the corporation’s share of PTE income and allocated dividend income;
• Include on Form 500A, Line 3(i), the corporation’s share of PTE income from Virginia sources, determined by the PTE using its own apportionment formula as if it were a corporation, along with any dividend income allocated to Virginia;
• Check the box on Form 500A, Line 3(i); and
• Include on the corporate return a statement listing the name and federal tax ID of each non-unitary PTE apportioned on a non-blended basis.
  
  

The Department said it will update the corporate income tax return for tax year 2025 and amend the instructions to include a checkbox. For returns for tax years 2024 and before, the Department directs taxpayers to its website for guidance on how to reflect the change made by FJ Mgmt. 

Because FJ Mgmt. represents a significant change from the Department’s long-standing policy on blended apportionment, Tax Bulletin 25-5 also offers transition relief for tax years 2024 and before. Under that relief, the Department will not require returns, including amended returns, to be filed in accordance with the new policy. Instead, it will allow taxpayers filing to apply the previous policy on blended apportionment, even if no unitary relationship exists. It also will allow returns, including amended returns, to be filed in conformity with FJ Mgmt. using the instructions described above and on its website.

To make use of the transition relief, taxpayers must file any returns, including amended returns, within the applicable limitations periods.