Virginia Addresses Apportionment of Pass-Through Entity Owner by Applying the Unitary Business Principle

By: Kate Hooker, State Income Tax Director

At a glance

• The main takeaway: A Virginia court decision addresses how the unitary business principle is applied to determine whether an owner of a PTE should compute its apportionment percentage by including its share of the PTE’s apportionment factors.
• Assess the impact: While some states provide guidance on how PTE owners should apportion and report income, not all do. The taxation of owners of PTEs is still a complex, fact-specific analysis that may depend on the relationship between the entities.
• Take the next step: Aprio’s State and Local Tax (SALT) team can help analyze the multistate treatment of your PTE income and whether your business has a unitary relationship.

Schedule a free consultation today to learn more!

The full story

For state income tax purposes, the unitary business principal is often thought of in the context of corporate combined filings (i.e., the members that are conducting a unitary business). However, the unitary business concept also has potential application for owners of pass-through entities (PTEs).

Generally, individual owners of a PTE, including partnerships, limited liability companies, and S corporations, include their share of PTE income, gain, loss, and deductions in their total income and report that income to the states as directed by their K-1 information, which is often based on apportionment at the PTE level. However, if the PTE owner is another entity, the owner may be required to include its share of the PTE’s apportionment factors with its own factors to determine the apportioned amount of income subject to tax in the state. Typically, this is required if there is a unitary business relationship between the PTE and its owner, unless state rules require otherwise.[1]

Understanding the case

This issue was the subject of a recent Virginia Court of Appeals decision which ruled that an owner of a PTE is not required to apportion income at the owner level by including its share of the PTE apportionment factors, because there is not a unitary business relationship between the PTE and the owner.[2] The decision provides guidance on how Virginia applies the unitary business principle between a PTE and its owner.

While the facts are a bit complicated, the relevant information is that during the years at issue, the taxpayer was engaged primarily in operating an oil refinery. It owned about 17% of a PTE, which was engaged in operating 550 interstate travel centers serving long-distance truckers throughout the U.S. and Canada. Its ownership was in the form of Class B shares, which offered limited input over the PTEs operations. The taxpayer sought a Virginia refund based on amended returns in which it apportioned income to Virginia based solely on its apportionment factors and separately reported its share of the PTE’s Virginia income. Virginia denied the refund, claiming that the taxpayer should have computed its Virginia income by combining its apportionment factors with its share of the PTE’s apportionment factors and applying that apportionment percentage to the taxpayer’s total income.

Applying the unitary business principle

The court analyzed the relationship between the two entities to determine if the “hallmarks of a unitary relationship”[3] existed. Those “hallmarks” are functional integration, centralized management, and economies of scale.

• Functional Integration examines whether there is an interconnection or interdependence between the business operations of the entities. This includes whether they share services, support one another, or the products of one support the products of another.

Court Ruling: The court determined that there was no functional integration between the businesses because they were in separate lines of business and shared no operational functions, like finance or human resources. The court acknowledged that the taxpayer sold products to the underlying PTE, but that was done in arms-length transactions.

• Centralized Management addresses whether the owner of the PTE is effectively controlling and managing the underlying PTE. This is evaluated based on whether the owner has rights granted through the PTE’s operating agreement to make independent decisions on behalf of the PTE.

Court Ruling: In this case, the court determined this hallmark was not met because the taxpayer owned only 17% of the PTE in Class B shares and was allowed to appoint only two of 11 PTE board members.   

• Economies of Scale evaluates whether the relationship creates efficiencies, market value, or cost benefits to either entity.

Court Ruling: The court determined that while there were transactions between the taxpayer and the PTE, they were not substantial to the purchaser’s business, and they were done using independently set price rates. Thus, there was no economic benefit to the two entities being related.

Despite Virginia’s numerous arguments, the court concluded that a unitary business relationship did not exist, and the taxpayer was entitled to its claimed refund.

The bottom line

The taxation of owners of PTEs is a complex, fact-specific analysis of the relationship between the entities. Some states have guidance on how owners should apportion and report income from PTEs, although such guidance can be complicated and may lack clarity, and other states may lack real guidance in this area. For PTE owners who have operations independent of the PTE, there could be a significant difference in tax in states where the only connection is the underlying PTE.

Aprio’s SALT team has experience analyzing and evaluating apportionment issues including whether businesses have unitary relationships. We can assist your business with a review of the multistate treatment of pass-through income and apportionment tso you aren’t paying more state tax than is required, and we can identify potential refund opportunities. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

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[1] This concept is sometimes referred to as owner-level apportionment (as opposed to PTE-level apportionment). 

[2] Commonwealth of Va., Dep’t of Taxation v. FJ Mgmt., Inc., Va. Ct. of Appeals, Record No. 0701-23-2 (Nov. 12, 2024).

[3] MeadWestvaco Corp. v. Ill. Dep’t of Revenue, 553 US 16 (2008)