05-40 | Virginia Tax

Tax Type

Individual Income Tax

Description

2001 Taxable year was calculated on a form 760 instead of a form 763

Topic

Payment and Refund

Residency

Date Issued

03-18-2005

March 18, 2005

Re: § 58.1-1824 Protective Claim: Individual Income Tax

Dear *****:

This will reply to the letter written on behalf of your client, ***** (the "Taxpayer"), in which you file a protective claim for refund of Virginia income tax withheld for the 2001 taxable year.

FACTS

The Taxpayer was granted incentive stock options ("ISOs") while she was a domiciliary resident of Virginia. As of January 2001, the Taxpayer abandoned her Virginia domicile and established permanent residency in ***** ("Country A"). From late January 2001 through January 2003, she exercised her stock options. Her former employer withheld Virginia income tax upon the exercise of her options.

For the 2001 taxable year, the Taxpayer filed a Virginia nonresident individual income tax return attributing all of the income from exercising stock options to Country A. Because the options were granted by a Virginia employer while the Taxpayer worked and lived in Virginia, the Department determined that the income was Virginia source income and subject to Virginia income tax. As such, the Taxpayer's income tax liability was adjusted. A refund was issued for the amount of withholding that exceeded the adjusted tax liability.

The Taxpayer files a protective claim for refund, claiming that the income generated from the stock options granted by the Virginia employer is not subject to Virginia income tax in accordance with the "grandfather provisions" set forth in the Tax Commissioner's determination in Public Document ("P.D.") 99-79 (4/20/99).

DETERMINATION

Pursuant to the authority granted the Tax Commissioner by Va. Code § 58.1- 1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Va. Code § 58.1-1821. As permitted by statute, your request has been treated as an appeal under Va. Code § 58.1-1821.

In P.D. 99-79, the Department held that the amount of a nonresident's Virginia source income with respect to ISOs granted in connection with Virginia employment will be determined at the time the stock is sold and income or gain is recognized for federal income tax purposes. The amount of Virginia source income of a nonresident is limited to the lesser of the income or gain recognized for federal income tax purposes or the amount by which the fair market value of the stock exceeded the option price at the date the ISO was exercised. Any appreciation in the value of the stock realized by a nonresident between the time an ISO is exercised and the time the stock is sold is investment income and not compensation attributable to employment in Virginia.

In P.D. 92-58 (4/29/92), a determination that addressed the withholding requirements of nonresidents, the Department stated in dicta that Virginia residents who once worked in Virginia, but are no longer residents, need not pay Virginia income tax on gains attributable to "stock option awards." Because P.D. 92-58 could have been interpreted to hold that nonresidents are not subject to income tax on stock options, P.D. 99-79 states:

- the department revokes those provisions of P.D. 92-58 on a prospective basis and replaces them with the finding contained in this ruling. Therefore, to the extent P.D. 92-58 conflicts with this ruling, it is hereby modified, and is replaced with this ruling effective for the first taxable year beginning after the date of this ruling.

Accordingly, the Department has applied the ruling in P.D. 99-79 on a prospective basis. The taxability of ISOs depends on when income on gains from stock received is recognized. Income and gains recognized by a nonresident of Virginia for taxable years beginning before April 20, 1999 are eligible for treatment under P.D. 9258. For ISOs granted for employment in Virginia, income and gains recognized by a nonresident for taxable years beginning on and after April 20, 1999 are subject to Virginia income tax. The date when a stock option is granted or exercised does not determine whether or not the income from the stock options is subject to Virginia income tax.

The Taxpayer contends that because she was granted the ISOs prior to January 1, 2000, P.D. 92-58 should control how income from her ISOs is taxed. Virginia source income with respect to ISOs granted in connection with Virginia employment, however, is determined at the time the stock is sold and income or gain is recognized for federal income tax purposes. Because the Taxpayer exercised ISOs in 2001 through 2003, she could not have sold any shares of stock acquired through the ISOs until after April 20, 1999. As such, the amount of Virginia source income of the Taxpayer is the lesser of the income or gain recognized for federal income tax purposes or the amount by which the fair market value of the stock exceeded the option price at the date the ISOs were exercised.

Based on the foregoing, the income from the ISOs is Virginia source income and subject to Virginia income tax. Therefore, I must reject your protective claim for refund. In analyzing this appeal, however, the Department discovered that the refund issued to the Taxpayer for the 2001 taxable year was calculated as though the Taxpayer was a resident of Virginia. The Taxpayer's liability has been recalculated as a nonresident pursuant to the enclosed schedules. A refund, including applicable interest, will be issued shortly.

The Code of Virginia sections and public documents cited, along with other reference documents, are available on-line in the Tax Policy Library section of the Department's web site, located at www.policylibrary.tax.virginia.gov. 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/52892B

Rulings of the Tax Commissioner