In Wirth v. Commonwealth, the Supreme Court of Pennsylvania held that Pennsylvania personal income tax applied to non-resident limited partners whose only connection with the state was the ownership of a small interest in a partnership that owned Pennsylvania property.  This ruling has weakened the effectiveness of the Due Process Clause as a defense against Pennsylvania taxation.

In 1984 and 1985, the non-resident appellants purchased interests in a Connecticut limited partnership organized solely for the purchase and management of a skyscraper located in Pittsburgh.  The appellants each owned between one-quarter of a unit to one unit of the partnership.  One unit equated to a 0.151281 percent interest.  The opinion does not indicate whether any of the numerous non-appellant partners owned significantly larger shares.  Further, all of the appellants were only passive investors and did not take “an active role in managing the [p]roperty.”  After 20 years of losses, the lender foreclosed on the property.  The appellants lost their entire investments, but the partnership reported a gain on its tax filings consisting of the unpaid balance of the nonrecourse note’s principal and the accrued interest, totaling $2,628,491,551.  As a result, the Pennsylvania Department of Revenue assessed personal income tax against the appellants, plus interest and penalties.

The appellants argued that the Commerce and Due Process Clauses prohibited the imposition of the Pennsylvania personal income tax on them.  The court did not determine whether the Commerce Clause bars the imposition of the personal income tax on these non-residents because the appellants waived this defense by not sufficiently distinguishing between the Commerce Clause and Due Process Clause arguments.

The court did reach a decision on whether the Due Process Clause would bar relief and held that the limited interest in the partnership amounted to minimum contacts with Pennsylvania.  The court agreed with the Department, which argued that the appellants’ interests, while limited, were “hardly passive” because of the large amount of money invested by each appellant, the extensive lifespan of the partnership and the partnership’s ownership of the Pennsylvania skyscraper.  (Interestingly, this statement from the court’s opinion echoes the Department’s brief; however, the Department instead describes the appellants’ actions as passive “on a technical level” and describes the appellants’ involvement with the partnership as “hardly trivial.”  The Department’s statement works to clear up confusion as to how an interest that is, by definition, passive  could not be passive, but does raise the question as to why the court would opt to affirmatively state that the appellants’ involvement was “hardly passive.”)  The court was also particularly concerned by the fact that had the appellants not had minimum contacts with Pennsylvania, any income earned by the appellants would escape Pennsylvania tax.

Practice Note: This case does not mean that other non-resident limited partners should accept Pennsylvania taxation.  Because the appellants did not adequately argue the Commerce Clause issues, this line of argument remains viable.  Further, the court’s concern with the possibility that income related to Pennsylvania property could escape Pennsylvania tax should be a question for the legislature, not the courts.  The legislature could have imposed a withholding requirement on limited partnerships, placing the tax burden squarely on an entity that clearly has the requisite tax nexus with the taxing jurisdiction.