How does an upper-tier partnership apportion Virginia income when all it has is K-1 income from lower tiers?

The question an upper tier faces

The upper tier here is a holding partnership, or an LLC taxed as one, that owns interests in several operating partnerships, has no payroll, property or sales in its own name, and earns only distributive shares reported on federal K-1s. Some of the lower tiers do business in Virginia and file Virginia returns; others do not. Each Virginia filer sends the upper tier a Schedule VK-1 showing an income figure and a Virginia apportionment percentage.

The upper tier has its own Virginia return to file, because "[e]very pass-through entity doing business in Virginia, or having income from Virginia sources, shall make a return" (Va. Code section 58.1-392(A)), and because the Department's instructions say "[t]here are no 'consolidated' or 'multilevel' PTE returns": each entity subject to filing files its own (Instructions for Preparing 2025 Form 502, Pass-Through Entities Required to File). The question is what goes in the apportionment schedule of an entity that, on its own books, has nothing to apportion with.

Virginia's rule: allocate dividends, apportion everything else

Owners of a pass-through entity are taxed in their individual capacities on the income passed through to them (Va. Code section 58.1-390.2). Each item of pass-through income keeps the character it has for federal purposes, and an item not characterized federally takes the character it would have had if the owner had realized it directly (Va. Code section 58.1-391(B)).

The allocation and apportionment rules are written for corporations. A corporation "having income from business activity which is taxable both within and without the Commonwealth shall allocate and apportion its Virginia taxable income as provided in §§ 58.1-407 through 58.1-420" (Va. Code section 58.1-406). The allocation rule has one subject: "Dividends received to the extent included in Virginia taxable income are allocable to the state of commercial domicile of the taxpaying corporation" (Va. Code section 58.1-407). Everything else is apportioned. The standard formula is the property factor plus the payroll factor plus twice the sales factor, divided by four (Va. Code section 58.1-408(A)), with special formulas for listed industries in Schedule 502A, Section A.

The Department applies those rules to pass-through entities through its instructions rather than through a regulation. The Form 502 instructions provide that a pass-through entity doing business "in Virginia and elsewhere in a manner such that its income would be subject to a tax on net income in Virginia and at least one other state" must "allocate and apportion its income in the same manner that is provided in Virginia law for corporations," that this "applies to all types of pass-through entities (partnerships, LLPs, LLCs, and S corporations)," and that "[d]ividends received are to be allocated to the state of commercial domicile, but all other income must be apportioned." They add: "An entity may not apportion its income based on divisional or separate accounting, or any other alternate method unless it has requested and received permission to do so in advance from the Department" (Instructions for Preparing 2025 Form 502, General Information). The Department's guidelines provide that "a pass-through entity must include its proportionate share of property, payroll, and sales for purposes of determining its Virginia apportionment factor" and "should, therefore, generally allocate and apportion income as prescribed in Va. Code §§ 58.1-407 through 58.1-420" (P.D. 15-240, December 22, 2015). The rulings say the same: partnerships with business inside and outside Virginia "compute their Virginia source income in accordance with the corporate statutory formula" (P.D. 03-76, describing former 23 VAC 10-130-20, since repealed), and "[t]he Code of Virginia does not provide for the allocation of income other than certain dividends" (P.D. 19-114, October 4, 2019; P.D. 21-36, March 16, 2021).

For the upper tier, a distributive share of rents, operating income or gain is apportionable, and only dividends are allocated, subject to the investment function adjustment and the unitary limit discussed below. Nor is there separate accounting by source: the instructions state that Virginia "does not allow for subtractions from apportionable income based on separate or divisional accounting, or for the exclusion of non-Virginia investment income" (Instructions for Preparing 2025 Form 502, Lines 4 to 7).

The lower tiers' factors flow up

The answer to the upper tier's question is in the Department's rulings, not the Code. In P.D. 88-165 (June 29, 1988), addressing layers of partnerships, corporations and investors above an operating partnership, the Department stated that "[t]he pass through of Virginia source income will continue to occur from partnership to partner" until "the income is passed through to a partner which is a taxable entity," and that a corporate general partner's factors "must include the pro rata share of the partnership's property" and the related payroll and sales.

P.D. 03-76 applied the principle to three tiers. An out-of-state partnership owned 40 percent of a second partnership, which was the 99 percent general partner of a third partnership operating a business entirely in Virginia. The top partnership had allocated its share of the operating income and the gain on the sale of the Virginia business entirely to Virginia. The Department held that "the pass-through of property, payroll, and sales attributable to both Virginia and everywhere must continue until a taxable entity is reached," so that the Virginia business's factors "would be passed through and added to the property, payroll and sales factors of the other activities" of each tier in turn, up to the taxpayer. The top partnership "incorrectly allocated these items of income to Virginia." The same reasoning appears in P.D. 07-118 (July 19, 2007), where an out-of-state LLC holding real estate through a multi-tier chain of LLCs asked to use separate accounting for an operating property several tiers down; the Department denied the request, holding that the property's "attributes and activities" flowed through the tiers to the taxpayer, which had to include "the appropriate amount" of that property's own property, payroll and sales "in determining income apportioned to Virginia."

The Department has refused the same shortcut at the top of a chain. In P.D. 97-59, the members of an upper-tier LLC asked to compute their Virginia income from the lower tier's separate accounting or, alternatively, from the lower tier's own property, payroll and sales; the Department denied both, reasoning that "[i]f the department permitted apportionment to occur at each partnership tier without a corresponding flow-through of property, payroll, and sales, significant income from Virginia sources passed through from intermediate levels could be eliminated simply by having an overall Virginia apportionment factor of zero in the final partnership tier." In P.D. 11-138 (July 28, 2011), a partnership investing in real estate entities asked to allocate income to Virginia "based on separate accounting" from "the income or loss of each entity," and the Department denied the request. Each tier also chooses its own formula: "[e]ach pass-through entity in a tiered pass-through entity structure is required to make its own determination as to which method of apportionment to use" (P.D. 15-240).

For a corporate owner the Department's rule is the same, and it covers LLCs, but it is now subject to a constitutional limit. A corporation holding a general partnership interest "must include its proportionate share of partnership property, payroll and sales in its own factors," a rule that "has also been expanded to include interests in limited liability companies," whether member-managed or manager-managed (P.D. 21-36, quoting P.D. 88-226; P.D. 19-114). The Department "generally presumes" pass-through income to be operational (P.D. 19-114), though the Court of Appeals has held that the Department's reading of section 58.1-391(B) "has essentially created a presumption that every owner of a pass-through entity forms a unitary business" (FJ Management). There is one published exception, for a corporation holding a limited partnership interest where "all general partners are unrelated third parties," the combined interests of the corporation and related parties are "10% or less of the profit and capital interests of the limited partnership," and "the structure is not a device primarily designed to avoid Virginia taxation" (P.D. 95-19, February 13, 1995). The Department has applied that exception to a tax-exempt corporation's small limited partner interests and declined to extend it to a qualified pension trust (P.D. 13-169, September 6, 2013). P.D. 15-240 cites P.D. 95-19 as authority for a pass-through entity's inclusion of factors but does not say whether the exception applies to one. Whether it reaches an upper-tier pass-through entity holding a small limited interest is not addressed in the rulings read for this article and is an open question. The Court of Appeals has since confined the corporate rule: the Department "would be constitutionally permitted to apply PTC's apportionment factors to FJM's out-of-state business activity only if FJM and PTC formed a unitary business," and section 58.1-391(B) "does not extend so far as to require the business characteristics of the pass-through entity itself to be imputed to its owners" (FJ Management, affirming refunds). The Department now keeps "the PTE's income from Virginia sources as determined and reported on its Schedule VK-1" separate from a non-unitary corporate owner's own apportionment, has the corporation check a box on Line 3(i) of Form 500A, and calls the approach "a temporary solution" (Virginia Tax Bulletin 25-5). The bulletin addresses corporations only, and the 2025 Form 502 instructions do not mention the decision.

The upper tier with only K-1 income therefore does have factors. Its property factor is its share of each lower tier's property in Virginia over its share of that property everywhere, and the payroll and sales factors are built the same way, with its own items, if any, added in. Its owners then take the result: "a nonresident individual owner uses the entity's Virginia apportioned income in determining his or her own Virginia nonresident percentage," and "a corporate owner may need to include the PTE's property, payroll, and sales factors in determining its own apportionment percentage" (Instructions for Preparing 2025 Form 502, General Information), which carries the lower tiers' factors one level further where the corporate owner and the entity are unitary.

What the forms carry, and what they do not

Schedule 502A, Section B computes the percentage from property, payroll and sales, with line 2(f) dividing the sum of the property factor, the payroll factor and the double-weighted sales factor by four, "reduced by the number of factors, if any, having no denominator." Section C has a line for dividends where the commercial domicile is in Virginia (line 2), lines for dividends and for "nonapportionable investment function income" and loss where it is not (lines 3(a) to 3(e)), and a line for apportionable income, which is everything else (line 4) (2025 Schedule 502A). There is no line for income from another pass-through entity, and none for income another entity has sourced to Virginia. On Form 500A, a corporation reporting a non-unitary pass-through entity's Virginia-source income checks the box on Line 3(i) (Virginia Tax Bulletin 25-5); Schedule 502A has no counterpart.

Schedule VK-1 passes the same structure down to the owner: line 4 is "Income allocated to Virginia (owner's share from PTE's Schedule 502A, Section C, Line 2)," line 5 is income allocated outside Virginia from Section C, line 3(e), line 6 is apportionable income from Section C, line 4, and line 7 is the lower tier's "Virginia apportionment percentage" from Section B (2025 Schedule VK-1). First, line 4 can only hold dividends of a Virginia-domiciled lower tier; a lower tier that reports its operating income as "allocated to Virginia" there has misused the line, and the upper tier cannot carry that figure onto its own Section C. Second, line 7 is a percentage, not a set of factors. Where the upper tier holds one lower tier and has no items or dividends of its own, that lower tier's percentage equals the percentage built from the upper tier's share of its factors, because one ownership share scales each numerator and denominator alike; where it holds more than one, no average of their percentages reproduces a factor built from their combined dollars, so the upper tier needs each lower tier's Section B dollars, Virginia and everywhere, and its own ownership share of each. Third, where the owner is another pass-through entity, the rulings require the factors to keep moving and the VK-1 does not carry them, so the upper tier obtains the factors from the lower tier directly.

A separate rule removes some upper tiers from the question. The Department's rulings have held that pass-through entities "established solely to invest in intangible personal property, such as stocks and bonds, and that have no employees and no real or tangible property, are not considered to be carrying on a trade or business," that their income from those intangibles "is not income from Virginia sources," and that they "are not required to file Form 502" (Instructions for Preparing 2025 Form 502, Investment Pass-Through Entities). That rule speaks to portfolios of stocks and bonds; an upper tier holding operating partnerships stands differently, because the rulings above carry their activities up to it.

A worked example

A holding partnership has no property, payroll or sales of its own and no dividends. It owns 60 percent of Partnership A, 50 percent of Partnership B and 25 percent of Partnership C, all operating businesses using the standard formula. Its federal income for the year is $1,000,000: $500,000 from A, $300,000 from B and $200,000 from C.

| At 100 percent | Property, Virginia / everywhere | Payroll, Virginia / everywhere | Sales, Virginia / everywhere | |---|---|---|---| | Partnership A | $6,000,000 / $10,000,000 | $1,000,000 / $2,000,000 | $4,000,000 / $8,000,000 | | Partnership B | $1,000,000 / $4,000,000 | $200,000 / $1,000,000 | $1,200,000 / $6,000,000 | | Partnership C | $0 / $8,000,000 | $0 / $1,200,000 | $0 / $4,800,000 |

The holding partnership's shares are: property $4,100,000 in Virginia over $10,000,000 everywhere (41 percent); payroll $700,000 over $2,000,000 (35 percent); sales $3,000,000 over $9,000,000 (33.33 percent). Under section 58.1-408(A), the percentage is (41 + 35 + 2 x 33.33) / 4, or about 35.67 percent, and the holding partnership's Virginia apportioned income is about $356,667. A nonresident individual owner's Virginia income is that owner's share of the $356,667. A corporate owner unitary with the holding partnership includes its share of the holding partnership's factors, which are the lower tiers' factors, in its own; one that is not unitary with it reports its share of the holding partnership's Virginia-source income (Virginia Tax Bulletin 25-5). Had the holding partnership owned only its 60 percent of A, its factors would be 60, 50 and 50 percent, its percentage 52.5 percent, and its Virginia income $262,500, the amount A's Schedule VK-1 reports.

The VK-1s from A and B show a different total. A's own percentage is 52.5 percent and B's is 21.25 percent, so A reports $262,500 of the holding partnership's $500,000 as Virginia apportioned income and B reports $63,750 of its $300,000; C does not file. Those figures total $326,250. The difference from $356,667 has two sources. C, which has no Virginia activity, adds $200,000 of income that the blended percentage reaches and adds denominators that dilute A's and B's factors; without C, the formula would give about $338,699 on $800,000. The rest is weighting: the formula weights each lower tier by the dollars in its factors, while the lower tiers' own figures weight each by the income it produced. Apportioning at each tier on that tier's own factors is the method the Department refused in P.D. 97-59, and within the statutory framework it requires permission under section 58.1-421. It is also the result Virginia Tax Bulletin 25-5 prescribes for a corporate owner of a non-unitary entity, and no ruling has said whether the same limit applies between tiers of pass-through entities. In another year the blend can run the other way.

When the factors cannot be obtained, or the formula overstates

Section 58.1-408(A) handles a missing factor: where the sales factor does not exist, the denominator is the number of existing factors, and where the sales factor exists but the property or payroll factor does not, the denominator is the number of existing factors plus one. The section does not address an entity for which no factor exists, and the line 2(f) instruction to reduce the divisor "by the number of factors, if any, having no denominator" produces no percentage when all three are missing. An upper tier that cannot obtain its lower tiers' factors is therefore not in a zero-factor case under the statute; on the rulings, its factors exist and are held by the lower tiers. The practical answer is to obtain them. Where corporate owners removed partnership factors and allocated partnership income, the Department kept the factors and denied the refund (P.D. 19-114) or upheld the assessment (P.D. 21-36), treating "any assessment of tax by the Department" as "prima facie correct" (P.D. 21-36, citing Va. Code section 58.1-205). On a record showing no unitary relationship, the Court of Appeals ordered refunds to a corporation that had removed a partnership's factors (FJ Management). For a corporate general partner, partnership property "may be treated as intangible property and excluded from the property factor" where its inclusion "does not materially affect the factor and information is difficult to obtain," if that treatment "is adequately disclosed" (23VAC10-120-160(A)(2)(b)); the rule speaks only to property.

Within the statutory framework, a different result requires the alternative method statute. Where the prescribed method "has operated or will so operate as to subject it to taxation on a greater portion of its Virginia taxable income than is reasonably attributable to business or sources within this Commonwealth," the taxpayer "shall be entitled to file with the Department a statement of its objections and of such alternative method of allocation or apportionment as it believes to be proper," and the Department, if it agrees, redetermines income by another method, "not exceeding, however, the amount which would be arrived at by application of the statutory rules" (Va. Code section 58.1-421). The instructions apply the same procedure to pass-through entities and state that permission "will be granted only in extraordinary circumstances" (Instructions for Preparing 2025 Form 502, Lines 4 to 7). The regulation sets the sequence for a corporation: file a return on the statutory method and pay the tax, then file an amended return on the proposed method, within the period for refund claims, with a statement of why the statutory method is inapplicable or inequitable; permission is generally granted year by year, and the regulation conditions it on a finding that the statutory method is unconstitutional as applied to the taxpayer or inequitable because it produces double taxation (23VAC10-120-280). A narrower adjustment exists for income from an asset serving an investment function unrelated to operations, on Section C lines 3(b) and 3(d), but only on "clear and cogent evidence that the capital investment was completely separate from its operations," with the related items removed from the factor denominators (Instructions for Preparing 2025 Form 502, Burden of Proof, referring to Virginia Tax Bulletin 93-4). The Department generally presumes pass-through income to be operational (P.D. 19-114), and the burden is "particularly heavy" where an asset "was clearly operational at any time" (Instructions for Preparing 2025 Form 502, Burden of Proof). No ruling read grants section 58.1-421 relief in a tiered case; the Department denied it in P.D. 97-59, 07-118 and 11-138.

Three questions remain open on the materials read. The first is whether the unitary limit of FJ Management applies to an upper-tier pass-through entity, and how: the decision and Virginia Tax Bulletin 25-5 address a corporate owner with a business of its own, and no ruling, bulletin or instruction addresses a holding entity with none whose lower tiers may or may not be unitary with one another. The second is the P.D. 95-19 exception for a pass-through entity, noted above. The third is whose commercial domicile governs a dividend that reaches the upper tier through a lower tier: section 58.1-391(B) keeps the item's character as a dividend, but the rulings read do not say whether the lower tier's or the upper tier's commercial domicile receives it.

Kentucky and Ohio write the flow-up into the statute

Kentucky. A pass-through entity doing business in Kentucky and elsewhere computes the numerator and denominator of each apportionment factor and provides them to each owner, and where it is a partner or member of another pass-through entity it is treated as owning its pro rata share of the other entity's property "and shall also include its pro rata share of the other pass-through entity's payroll and sales" (KRS 141.206(10)(a), (b)). The rule applies "to each level of multiple-tiered pass-through entities," and the attribution carries into the entity's apportionment fraction, which for taxable years beginning on or after January 1, 2018 is computed as provided in KRS 141.120 (KRS 141.206(10)(c), (d), (11)(b), as amended effective July 15, 2026). Kentucky therefore gives by statute what Virginia gives by ruling, and adds what Virginia's forms lack: a duty on the lower tier to deliver factor numerators and denominators, not a percentage.

Ohio. In all apportionment and allocation computations under the income tax chapter, each person includes its "entire distributive share or proportionate share" of the income items and the "property, compensation, and sales" of any pass-through entity in which it has a direct or indirect interest, and a pass-through entity's share of another pass-through entity's items is included in computing the person's share; "[t]hose items shall be in the same form as was recognized by the pass-through entity" (Ohio Rev. Code section 5747.231). Ohio keeps a business and nonbusiness distinction, which Virginia does not, but its tiered rule is the same aggregate rule.

Not every state works this way. The library's article on whether lower-tier factors flow up describes the separate-entity states, which pass up a state-sourced amount instead of factors, and the entity-level states, which pass up nothing; the Virginia answer does not carry to them.

Practice notes

The sound sequence for an upper tier in Virginia starts with the structure chart: each lower tier, the ownership share at each link, whether it files in Virginia, and which formula it uses. The upper tier then requests each lower tier's Schedule 502A, Section B dollars, not the VK-1 percentage, and builds its own Section B from its shares, through every tier. A lower tier that has put operating income on the "allocated to Virginia" line of a VK-1 is asked for a corrected schedule before the upper tier files, because that figure has no place on the upper tier's Section C. Where a lower tier will not or cannot supply factors, the file records the request and the response, and the choices are obtaining the data, the property factor disclosure rule where it applies, and a section 58.1-421 request filed in the sequence the regulation describes. Where a lower tier, the upper tier or a corporate owner above them may not form a unitary business, the file records the facts on functional integration, centralized management and economies of scale, and the position taken in light of FJ Management. Upper tiers holding small limited interests, and those whose K-1s carry dividends from lower tiers domiciled elsewhere, document their position on the open questions in writing before the return is filed. G&G State Tax Group provides tiered pass-through apportionment analysis and alternative method requests in Virginia and other states alongside its state and local tax practice.