Good news for nonresident members of limited liability companies (“LLCs”) operating in Virginia. In DiBelardino v. Virginia Department of Taxation, 1 the Virginia Circuit Court for the City of Richmond held that nonresident LLC members could not be subject to Virginia income tax merely because the LLC of which they were a member conducted business within the state. Rather, the Court held that some property ownership was required before the constitutional requirements of due process could be met.

In DiBelardino, members of X-IT, a Delaware LLC qualified to do business in Virginia, challenged a personal income tax assessment issued by the Virginia Department of Taxation (the “Department”). X-IT’s members, the DiBelardinos and Dutton, each alleged that income they received from the LLC was not taxable in Virginia. The LLC, which held a patent for a fire escape ladder, had recently settled a lawsuit with a competitor. The Department alleged that the settlement proceeds received by the members should be subject to Virginia income tax.

The Nature of The Income

The taxpayers argued that the nature of their involvement with X-IT was having a right to a return on their investment in X-IT, not the right to income from property or a business that could be sourced to Virginia. Because Virginia taxes apply only to “income, gain, loss and deduction” from Virginia sources, a nonresident is subject to tax only if the nonresident owns property in Virginia or is personally engaged in a trade or business in Virginia. See VA. CODE ANN. § 58.1-302 (West 2007). The taxpayers argued in this case that there was no Virginia source income to tax.

X-IT was divided in a manner similar to a traditional limited partnership. Members could own either an “investor” or “management” unit in the firm. Only a member holding a management unit maintained control over company operations. The taxpayers in DiBelardino held investor units. Other than X-IT, Dutton had little contact with the state of Virginia. The DiBelardinos, on the other hand, owned two bed-and-breakfasts in Norfolk, Virginia, but did not otherwise have any further contact with the state.

The Department took the position that because the LLC was treated as a partnership under federal law, any income passing though the LLC would have the same character for Virginia income tax as it would for federal income tax purposes and because X-IT was licensed to do business in the state of Virginia, the proceeds of the lawsuit settlement might be subject to Virginia income tax. While the court initially agreed with the Department’s appraisal of the matter, it questioned its constitutional authority to impose the tax. The court noted, “While the court agrees with the Department’s assessment of the means allowed for treating limited liability company income as partnership income for Virginia income tax purposes, the constitutionality of such tax treatment as applied under the facts presented by these plaintiffs remains.”

The Due Process Consideration

Ultimately, the court conceded that before any of the plaintiffs could be subject to tax, the minimum contacts requirement demanded by the Constitution must first be satisfied. In order to satisfy the threshold elements of due process, the taxpayer must have minimum contacts with the state, and the application of the tax must not violate notions of fundamental fairness.

The court found that the mere fact that the company had authority to do business in Virginia was not enough. Realizing that the investor unit held by the plaintiffs did not create the necessary property interest in the state of Virginia to justify the imposition of a state income tax, the court held that an additional property interest was required. Therefore, while the court could not justify taxing Dutton, it held that the DiBeldarinos’ property interest in their Norfolk bed-and-breakfasts was sufficient to satisfy the requirements of due process.


As a whole, the opinion in DiBelardino appears logically sound. The court, through its bifurcated analysis, appears to have reached the right result. While the income from the lawsuit could likely be sourced to Virginia, this is not sufficient to exert taxing authority over a party without the required minimum contacts to the state. Additionally, based on X-IT’s structure, the investor units held by the taxpayer appear to resemble shares of stock more closely than they do partnership interests. Merely owning stock in a corporation that does business in a particular state is not sufficient to establish nexus and, by comparison, neither should an LLC interest with no control over the entity’s affairs.

While the opinion appears well-reasoned, neither the Department of Taxation nor the DiBelardinos appear happy with it as both have appealed it to the Virginia Supreme Court, which has agreed to hear the case. In the meantime, caselaw holds that ownership of an LLC interest with no right to control the LLC does not create a property interest sufficient to justify nexus in Virginia.