April 12, 2023
Re: § 58.1-1821 Appeal: Individual Income Tax
Dear *****:
This will respond to your letter in which you seek a refund of the individual income tax paid by ***** (the “Taxpayers”) for the taxable year ended December 31, 2017.
FACTS
The Taxpayers, a husband and wife, filed a joint Virginia individual income tax return for the 2017 taxable year. The husband was a partner in a partnership that placed equipment in service in 2009. Fixed date conformity (FDC) additions and subtractions for bonus depreciation were claimed each year from 2009 through 2017 by the partnership and were passed through to the Taxpayers in accordance with the husband’s partnership interest. The husband sold his partnership interest to the remaining partners in 2017. At the time of the sale, the total of the additions from the bonus depreciation exceeded the total of the subtractions.
The Taxpayers claimed a long-term capital gain subtraction on their 2017 Virginia individual income tax return for the amount that the bonus depreciation additions exceeded the subtractions at the time of the partnership interest sale. Under review, the Department disallowed the subtraction on the basis that the Taxpayers did not show that the sale was of stock in a qualified business. In addition, the Department recognized that the Taxpayers had a balance of FDC additions at the time of the sale, but concluded that the Taxpayers could not subtract them on their Virginia return.
The Taxpayers paid the assessment and appealed. The Taxpayers concede that they were not eligible to claim a subtraction for long-term capital gain attributable to a qualified business. They contend, however, that they were entitled to claim a subtraction for the amount that the bonus depreciation additions exceeded the subtractions at the time of the sale of the partnership interest.
DETERMINATION
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.
In 2003, Virginia began conforming to the IRC as of a specific or fixed date. Since then, the General Assembly has enacted legislation to move the date of conformity forward each year. Effective for taxable years beginning on and after January 1, 2016, Virginia’s conformity date was advanced from December 31, 2016, to December 31, 2017 with limited exceptions. See Virginia Tax Bulletin (VTB) 18-1 (2/26/2018). For the taxable year at issue, Virginia continued to prohibit bonus depreciation allowed for certain assets under IRC § 168(k). VTB 18-1 instructs taxpayers to consult the instructions for the appropriate 2017 Virginia income tax form about how to make adjustments related to bonus depreciation.
The instructions for the 2017 Virginia returns for corporations (Form 500) and pass-through entities (Form 502) provide that:
If an asset was disposed of in 2017 and such asset received the special 30% or 50% bonus depreciation deduction for federal purposes in any of the years 2001 through 2017, and a gain or loss was recognized for federal purposes, then the gain or loss must be recomputed as if such asset did not receive the special 30% or 50% bonus depreciation deduction for federal purposes in any of the years 2001 through 2017. The adjustment will be the difference in the federal and Virginia basis of the asset when sold. If the federal basis of the asset is lower than the Virginia basis (resulting in a greater gain for federal purposes), then the difference between the two bases is included as a subtraction on the Virginia return.
As FDC adjustments related to bonus depreciation apply only to businesses, this provision was not included in the instructions for individual returns. Nevertheless, this issue arises from partnership transactions so taxpayers will be allowed an adjustment for the disposition of assets that have different bases for federal and Virginia income tax purposes as the result of FDC adjustments as described in the above instructions from Forms 500 and 502.
Because the Taxpayer was required to report FDC additions for Virginia income tax purposes to offset the federal bonus depreciation deductions that were not allowed in the computation of his Virginia taxable income, his basis in the partnership interest was higher for Virginia income tax purposes than it was for federal income tax purposes. Thus, the gain would have been less for Virginia income tax purposes. Because the computation of VTI begins with FAGI, unless the Taxpayer is allowed a subtraction in order to correctly reduce the gain to account for the basis difference, his Virginia income tax liability for the transaction would not properly reflect his different Virginia basis in the partnership interest.
Accordingly, the case will be returned to the audit staff to allow the appropriate subtraction amount, adjust the assessment, and issue a refund as warranted. If the audit staff requires more information from the Taxpayer in order to determine the amount, the Taxpayer must provide the information within the time allotted.
The Code of Virginia sections and Tax Bulletin 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/3879.B