Document Number
03-66
Tax Type
Individual Income Tax
Description
Domiciliary and out of state residents, NOL's
Topic
Allocation and Apportionment
Computation of Tax
Returns/Payments/Records
Date Issued
08-14-2003

August 14, 2003



Re: § 58.1-1821 Application: Individual Income Tax


Dear *****:

This will reply to your letter in which you seek correction of the individual income
assessment issued to your clients, ************ (the "Taxpayers") for the taxable year ended December 31, 2001.
FACTS

The Taxpayers were domiciliary and actual residents of another state during the 1995 through 2001 taxable years. The Taxpayers were the sole owners of a business in Virginia that was initially conducted through a limited liability company and subsequently through a limited partnership. For each year from 1995 through 2001, the business sustained a net operating loss ("NOL"). The Taxpayers filed Virginia nonresident returns for these years that reflected the losses. During the years in question, the Taxpayers had no other Virginia source income.

In 2001, the Taxpayers sold the business for a gain. On their 2001 Virginia nonresident income tax return, the Taxpayers offset the capital gain reported in the numerator of the nonresident apportionment ratio by the total of the NOLs from 1995 through 2001. The Department disallowed the offset for the NOLs from 1995 through 2000 and assessed additional Virginia income tax and interest. You contest disallowing the preceding taxable years' NOLs to offset the capital gain, asserting that Virginia's method of calculating the taxable income of nonresidents treats nonresidents inconsistently and, thus, producing unconstitutional results.
DETERMINATION
    • The statute at issue, Va. Code § 58.1-325, provides in pertinent part:
    • The Virginia taxable income of a nonresident individual, partner or beneficiary shall be an amount bearing the same proportion to his Virginia taxable income, computed as though he were a resident, as the net amount of his income, gain, loss and deductions from Virginia sources bears to the net amount of his income, gain, loss and deductions from all sources.

There is no provision in the Code of Virginia for a Virginia NOL. The starting point on a Virginia individual income tax return is federal adjusted gross income ("FAGI"). See Va. Code §§ 58.1-301 and 58.1-322. Accordingly, the Department has determined that these statutes embrace federal treatment for NOLs, but only to the extent such losses are included in FAGI for the year in question.

As such, no NOL can be carried forward to any year without a corresponding carryforward for federal purposes. See Public Document ("P.D.") 92-133 (8/4/92). Therefore, if the Taxpayer's NOLs for the 1995 through 2000 taxable years were not carried forward to the 2001 taxable years for federal purposes, no NOL can be carried forward to 2001 for Virginia income tax purposes.

You acknowledge that Virginia law disallows nonresidents to carryforward NOLs to offset future Virginia source income. You contend, however, that nonresident taxpayers who have both Virginia source income and income from other sources may be subject to a greater Virginia income tax than nonresident taxpayers with only Virginia source income. You argue that Virginia's formula for taxing nonresident individuals is unconstitutional.

You have cited Miller Bros. v. Maryland, 347 U.S. 340 (1954), Nashville Chattanooga & St. L. Ry. v. Missouri State Tax Com'n, 310 U.S. 362 (1940) and Norfolk & W. Ry. v. Missouri State Tax Comm'n, 390 U.S. 317 (1968) for the proposition that a state may not tax beyond its borders and produce a grossly distorted result. I agree that Virginia may not tax income without its borders; however, the cases you have cited do not demonstrate that Virginia's method of taxing nonresidents is unconstitutional.

It is well established that a state may tax income derived from property located within such state and business transacted within such state that is owned and managed from without by a citizen and resident of another state. See Shaffer v. Carter. State Auditor. et al., 252 U.S. 37 (1920). In addition, progressive tax systems that apportion the tax burden based on the taxpayer's ability to pay have been held to be unquestionably constitutional. See Frank R. Brushaber v. Union Pacific Railroad Company, 240 U.S. 1 (1916). In fact, when the United States Supreme Court denied the writ of certiorari in the case of Lawrence J. Brady v. State of New York, 80 N.Y.2d 596 (1992), cert. denied, 509 U.S. 905 (1993), it let stand the lower court's ruling upholding the constitutionality of a method of apportioning the income of nonresident taxpayers that is substantially similar to the method employed by Virginia.

While you agree that the NOLs could not be carried forward for purposes of computing the Virginia taxable income of the Taxpayers, you argue that the apportionment ratio is wholly independent of either FAGI or Virginia taxable income. You aver that the numerator of the ratio should be confined exclusively to the net income for federal income tax purposes determined as if total income were confined only to Virginia sources. Under this logic, the NOLs would be allowed to be carried forward to reduce income from Virginia sources because they were not eliminated by income from outside Virginia included in FAGI in the taxable years the losses occurred.

You believe this method would eliminate the inequity in treatment between nonresident taxpayers that have income only from Virginia sources and nonresident taxpayers that receive income from Virginia and at least one other state. I disagree.

Pursuant to Title 23 of the Virginia Administrative Code ("VAC") 10-110-180, a nonresident individual's income subject to Virginia tax is his Virginia taxable income computed as a resident multiplied by the ratio of net income, gain, loss and deductions from Virginia sources to net income, gain, loss and deductions from all sources. Title 23 VAC 10-110-180(B) goes on to define income included in the apportionment ratio. In determining the apportionment ratio, the regulation includes items of income that are not included in FAGI, such as, interest on obligations of states other than Virginia and lump sum distributions. Consequently, the numerator of the ratio is not confined exclusively to the net income for federal income tax purposes. Further, neither the statute nor the regulation contemplates including any income or loss not recognized for either Virginia or federal income tax purposes in that taxable year.

Virginia's method of taxing income of nonresident individuals is consistent with its treatment of Virginia residents. If the scenario were reversed, the Taxpayers, as Virginia residents, would have had the benefit of reducing Virginia taxable income by the NOLs from the business for the 1995 through 2000 taxable years and then be eligible for a credit for tax paid to the other state as a result of the net gain taxable in the other state in 2001.

Under Virginia's structure, the Taxpayers were able to use the NOLs generated by the Virginia business to reduce income taxable in their state of residence for the 1995 through 2000 taxable years. In 2001, the Taxpayers' income subject to Virginia tax is their Virginia taxable income computed as a resident multiplied by the ratio of NOL of the Virginia business plus the gain from the sale of the interest in the Virginia limited partnership divided by the Taxpayers' net income, gain, loss and deductions from all sources. Thus, the Taxpayers' have not lost the tax benefits of the NOLs.

A review of the individual income tax laws of the Taxpayers' state of residence indicates a system similar to Virginia. The Taxpayers should have paid less income tax to their state of residence for the 1995 through 2000 taxable years than they would have if they had not received the losses from the Virginia business. Now they want to use these same losses to reduce their Virginia income tax in 2001. In essence, the Taxpayers' method of computing the numerator of apportionment formula allows a double benefit for the NOLs.

Accordingly, Virginia's statute for calculating a nonresident taxpayer's taxable income as if they were residents and multiplying this amount by the ratio of income, gain, losses, and deductions from Virginia sources to income, gain, losses, and deductions from all sources is constitutional and the Department's assessment is valid. Consequently, these NOLs cannot be used in determining the amount of the Taxpayer's Virginia taxable that was apportioned to Virginia for the 2001 taxable year.

The outstanding balance of the assessment through the date of this determination is ***** interest). No additional interest will accrue provided the outstanding balance is paid within 30 days of the date of this letter. The Taxpayers should remit their payment to: Virginia Department of Taxation, 3600 West Broad Street, Suite 160, Richmond, Virginia 23230, Attention: *****. Any questions concerning payment of the assessment should be directed to ***** at *****.

Copies of Code of Virginia sections, regulations and public documents cited are available on-line in the Tax Policy Library section of the Department's web site, located at www.tax.state.va.us. If you have any questions regarding this determination, you may contact ***** in the Office of Policy and Administration, Appeals and Rulings, at *****.
                • Sincerely,

                • Kenneth W. Thorson
                  Tax Commissioner


AR/44067B

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46