Rulings of the Tax Commissioner

March 22, 2023

Re:    § 58.1-1821 Application: Individual Income Tax

Dear *****

This will reply to your letter in which you seek correction of the individual income tax assessments issued to ***** (the “Taxpayers”), for the taxable years ended December 31, 2019, through 2021.  

FACTS

The Taxpayers, a husband and wife, were residents of Virginia during the taxable years at issue. They both were employed in North Carolina. The Taxpayers’ employers withheld income tax for North Carolina but did not withhold tax for Virginia. The Taxpayers filed Virginia resident returns for the 2019 through 2021 taxable years and reported the tax withheld for North Carolina as the tax withheld for Virginia. The Department disallowed the withholding tax reported on the returns and issued assessments. The Taxpayers appeal, contending that not allowing them a credit for income tax paid to North Carolina would result in double taxation.  

DETERMINATION

Taxation of Virginia Residents

Virginia Code § 58.1-301 provides, with certain exceptions, that the terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia. For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income (VTI) with federal adjusted gross income (FAGI). Income properly included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia.

As stated above, because the Taxpayers were Virginia residents, they were subject to tax on all of their income, regardless of the fact that the income was earned in North Carolina. Because the tax was withheld for North Carolina, Virginia never received the tax payments claimed on their Virginia returns as withholding. As such, the Department properly denied credit for the North Carolina withholding the Taxpayers claimed on their Virginia return.   

Out of State Tax Credit

The Taxpayers contend that they should receive a credit for the tax that they paid to North Carolina, otherwise they would be paying a double tax on their income. Virginia Code § 58.1-332 A allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or on any gain from the sale of a capital asset. The intent of the credit is to grant Virginia residents relief in situations in which they are taxed by both Virginia and another state on these types of income during the same taxable year.

As a general rule, the credit is limited to the lesser of: (1) the amount of tax actually paid to the other state; or (2) the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state. In the case of a Virginia resident who pays income tax to a state that borders Virginia, like North Carolina, a special rule can apply.

If certain criteria are met, the limitation that restricts the credit to the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state is disregarded. The special rule will apply if the income subject to tax in a single state contiguous to Virginia is less than Virginia taxable income and all of the income from sources outside Virginia is earned income or business income reported on federal form Schedule C from that single contiguous state. In such instances, the Virginia resident will be entitled to a credit equal to the lesser of: (1) the amount of income tax actually paid to the contiguous state; or (2) 100% of their Virginia income tax liability. See Virginia Code § 58.1-332 A. Under either rule, in order to claim the credit, Virginia residents must be both liable for and pay the income tax due to the other state. See Virginia Code § 58.1-322 A.  

The Taxpayers have indicated that they did not file North Carolina income tax returns, but they have provided copies of their Form W-2s issued by their employers. They contend that the Form W-2s are sufficient to show that they were entitled to claim the out-of-state credit.     

However, Virginia Code § 58.1-332(A), in pertinent part, places a limitation on the credit:

The credit allowable under this section shall not exceed: ...such proportion of the income tax otherwise payable by him under this chapter as his income upon which the tax imposed by the other state was computed bears to his Virginia taxable income upon which the tax imposed by this Commonwealth was computed... (Emphasis added).

Because of this limitation on the credit, a copy of Form W-2 showing income tax was withheld by another state is insufficient for the Department to allow this credit. Instead, a taxpayer must provide a copy of the return filed with the other state so that it can be determined if the limitation imposed by Virginia Code § 58.1-332 A is applicable. See Public Document (P.D.) 95-174 (6/27/1995). Moreover, the amount of tax withheld for another state does not necessarily represent a taxpayer’s liability in that state. The amount withheld, for example, does not take into account any additions, exemptions, subtractions, deductions, or credits that may be utilized in calculating a taxpayer’s tax liability.  

North Carolina G.S. § 105-153.8(a)(2) provides that nonresident individuals of North Carolina who have income derived from a business, trade, profession, or occupation carried on in North Carolina and meet certain filing threshold amounts are required to file a North Carolina income tax return. Because the Taxpayers’ wages were derived from occupations carried on in North Carolina and exceeded the filing threshold amounts described in North Carolina law, it appears that they were required to file North Carolina nonresident income tax returns.

CONCLUSION

The Taxpayers could not claim income tax withheld and paid to North Carolina as payments of Virginia income tax on their Virginia returns. As such, their request for the abatement of the assessments issued for the taxable years ended December 31, 2019 through 2021 cannot be granted.
    
The Taxpayers may, however, be able to claim the out of state tax credit for income tax paid to North Carolina. In order to claim the credits, they should file nonresident North Carolina income tax returns to determine their actual North Carolina income tax liability, then they should file amended Virginia income tax returns, including the Virginia Schedule OSC, for the 2019 through 2021 taxable years. The amended returns, including full copies of the North Carolina returns, should be mailed to: Virginia Department of Taxation, Appeals and Rulings, Attn: *****, Post Office Box 27203, Richmond, Virginia 23261-7203. The requested documents should be sent within 60 days from the date of this letter. Once the returns are received, they will be processed and the assessments adjusted accordingly. If the Taxpayers fail to respond within the time allowed, the assessments will be considered to be correct.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.

Sincerely,

Craig M. Burns
Tax Commissioner

                    
AR/4405.B