Withholding by pass-thru entities

When I and others visited the General Assembly last January at the invitation of LG Bill Bolling, one of the speakers was State Senator Mark Obenshain (R-26th), who talked about a bill he had gotten thru the Finance Committee by a 15-0 vote. The bill promised the Holy Grail: it generates revenues without raising taxes.

I kinda forgot about this bill, but in looking thru some stuff, I found out that the bill passed and is awaiting the governor’s signature. At the time Sen. Obenshain mentioned this bill, I said it would be onerous on small businesses. In looking at the text of the bill, I am more convinced than ever that it will be onerous. The bill requires the withholding of 5% on the income of nonresident owners of pass-through entities, i.e., partnerships, LLCs, and S Corporations.

After practicing for more than 20 years and with clients all over the country, I’ve seen my share of this kind of thing. What ends up happening is that the business withholds and remits the tax. The nonresident individual either doesn’t file in that state (because the amount withheld is so small) or does so at a significant tax preparation cost. If the nonresident owner doesn’t file, the money reverts to the state. That’s where the windfall comes in and why it “generates revenues without raising taxes.”

Besides that, the bill requires that at least 90% of money that is withheld be remitted to the state by the due date of the tax return, not including extensions. Remember, we are talking pass-through entities here, which means that the Virginia source income is the net profit of the business. There is a reason why so many pass-though entities file extensions: they simply don’t have the information together. What I expect will happen is a whole lot of penalties. (Maybe that is part of the plan for generating revenue. I know the change in the penalties for late filing of corporate returns certainly did – but that’s a post for another day.)

There is a hardship exemption and the bill directs the Tax Commissioner, Janie Bowen, to come up with what qualifies. If Commissioner Bowen still reads blogs, let me offer one suggestion.

Exempt entities whose total receipts and total assets are less than $250,000. This takes away the hardship of the small businesses as well as eliminates the small dollar K-1 amounts.

People are always talking about how business-friendly Virginia is. This is an opportunity to demonstrate that such friendliness extends not only to big businesses, but to small ones as well.

Technorati Tags: Virginia Income Tax