Tax Type
Individual Income Tax
Description
Virginia law does not automatically allow a claim for credit for tax paid to another state
Topic
Appropriateness of Audit Methodology
Credits
Date Issued
04-11-2006
April 11, 2006
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek correction of an individual income tax assessment issued to your clients, ***** (the "Taxpayers"), for the 2001 taxable year. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayers are Virginia residents who claimed an out-of-state tax credit on their Virginia return for income taxes paid to Iowa as nonresidents on their 2001 Iowa income tax return. In computing the credit, the Taxpayers reported the amount of their wages as the qualifying income on which the credit was based. Under audit, the Department reduced the out-of-state tax credit claimed to reflect the taxable income on which the credit was based and issued an assessment.
The Taxpayers paid the assessment and have filed a claim for refund. You assert that the audit adjustment unfairly imposes Virginia income tax on non-Virginia income. You further contend that the reduction in the out-of-state tax credit is inconsistent with Title 23 Virginia Administrative Code ("VAC") 10-110-180.
DETERMINATION
Virginia Code § 58.1-332 allows Virginia residents a credit on their Virginia individual income tax return for income taxes paid to another state provided the income is either earned or business income, or gain from the sale of a capital asset. 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 . . .
Therefore, Virginia law does not automatically allow a taxpayer to claim a credit for the total amount of tax paid to another state. Rather, the credit is limited to the lesser of: (i) the amount of tax actually paid to the other state (the "tentative credit"); or (ii) the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state (the "limitation"). The limitation is computed by multiplying the individual's Virginia tax liability by a fraction, the numerator of which is the income upon which the other state's tax is imposed, and the denominator of which is Virginia taxable income.
While aimed at preventing double taxation, Virginia law does not necessarily provide a credit for the entire amount of tax paid to another state. A resident incurring a tax liability to another state that imposes a tax burden that is greater than Virginia's will be credited, in most instances, only to the extent of the Virginia tax on such income.
Proportion of Income
Virginia, like most states, determines the amount of nonresident income subject to Virginia income taxation by applying the percentage of income from sources located within Virginia's borders as compared to income earned from all sources, to the total taxable income amount. The tax is then computed on the amount of taxable income that has been prorated to Virginia.
Iowa requires a nonresident to compute his tax as if he were a resident, and then prorates the tax. Under Iowa's computation, the nonresident determines the percentage of income earned outside Iowa, prorates the tax to income from sources outside Iowa, and then subtracts the prorated tax from the tax computed as a resident.
For purposes of determining the Virginia credit for tax paid to another state, Public Document ("P.D.") 94-91 (3/29/94) specifies the calculation for determining the amount of income on which the nonresident tax is based for states that tax nonresidents by prorating the tax instead of prorating the taxable income. This ruling requires that the allocation percentage calculated on the other state's nonresident return (which is used to convert the resident tax to the nonresident tax) must be applied to the other state's taxable income calculated as a resident in order to determine the other state's nonresident taxable income. The result is used in the numerator of the fraction to compute the limitation imposed by Va. Code § 58.1-332 A.
Although producing the same result as New York, Iowa's computation takes a different approach. Instead of prorating the tax based on the portion of nonresident income sourced to the state (like New York), Iowa grants a credit for the amount of tax computed on income not subject to Iowa income tax.
The computation of the credit includes a calculation of the ratio of a taxpayer's nonresident income sourced to Iowa. This is the allocation percentage that a taxpayer must apply to the Iowa's taxable income calculated as a resident in order to determine the Iowa's nonresident taxable income included in the numerator of the fraction to compute the Virginia credit limitation.
The Taxpayer contends that Virginia's methodology is not appropriate in that there is no concept of the nonresident Iowa taxable income. Rather, he asserts that the correct concept is to consider the total income from Iowa sources. The Taxpayer asserts that his total income should be applied as the taxable income on which the other state's tax is based for purposes of computing the Virginia credit.
Consideration of a nonresident's income from all sources in its tax calculation has no relevance in computing the credit limitation imposed by Va. Code § 58.1-332 A. The Virginia credit limitation clearly contemplates a net taxable income on which the other state imposes its tax.
The Department has found that the allocation method is wholly consistent with Virginia law and the instructions for computing the Virginia credit. By comparison, the method you propose would result in a credit equal to 100% of the tax paid to Iowa in almost every instance, distorting the intention of the Virginia limitation. As such, the Department finds the method described in P.D. 94-91, as applied in this case with a slight modification, conforms to the intent of the limitation language of Va. Code § 58.1-332 A by determining the proper amount on which the Iowa nonresident tax is actually imposed.
Recapturing Income
The Taxpayers further believe that the Department's method does not give proper regard to a taxpayer's exempt income in that the Iowa computation of taxable income provides a subtraction of federal tax payments, specifically federal withholding and estimated tax payments. You propose that a taxpayer's exempt income be subtracted from the denominator of the Iowa nonresident allocation percentage, and the resulting percentage be applied to the Iowa resident taxable income in order to determine the amount on which the Iowa tax is based.
Your methodology would omit an important element of the Iowa nonresident tax formula. A subtraction for exempt income is permitted in determining Iowa taxable income. This subtraction, however, is not considered in the Iowa nonresident allocation percentage. Consequently, exempt income affects the amount of a nonresident's Iowa tax. By way of comparison, the Virginia nonresident tax formula functions in much the same manner. The Department, therefore, cannot agree that your method accurately portrays the amount of income subject to tax when an Iowa nonresident has exempt income.
Regulation
The Taxpayers contend that the Department's reduction in the computation of the credit for income tax paid to another state for nonresidents is inconsistent with Title 23 VAC 10-110-180. You suggest that the allowable deduction of federal taxes for Iowa purposes would be viewed similar to an itemized deduction, and not as a business deduction that is attributable to an income source.
Title 23 VAC 10-110-180 provides guidance on identifying the types of income a nonresident individual may receive that is considered taxable by Virginia. The Taxpayers are nonresidents of Iowa, not Virginia. The manner in which Virginia imposes income tax on nonresidents of Virginia, therefore, is completely irrelevant in this case. If Iowa, however, defined taxable income of a nonresident in the same manner as Virginia, the resulting limitation under Va. Code § 58.1-332 A would be substantially the same. The difference would be that the Taxpayer's Iowa income tax would be reduced because less income would be taxed in Iowa's highest tax bracket. Accordingly, the Department's method for computing the Virginia credit limitation in this case is consistent with Virginia law.
Form Instructions
The Taxpayers also state that the Department's adjustments, respecting qualifying taxable income on which the other state's income is based, do not conform to the Department's instructions for computation of the Credit for Tax Paid to Another State section on the 2001 Virginia Schedule ADJ, and therefore, are inadequate to properly compute the credit.
Regrettably, it is not feasible for the Department to include a detailed explanation in the instruction booklet for computing the credit for every state that imposes an income tax. Another consideration is a state's ability to change its tax laws in any given year, creating the onerous task of annually reviewing the laws of all states in order to update such instructions in advance of printing and distribution. The instructions provided conform to the requirements of Va. Code § 58.1-332.
The instructions also include guidance for taxpayers with income from states that compute the tax on total taxable income from all sources and then adjust the amount subject to tax by an allocation percentage. As such, the instructions put taxpayers on notice that they may not be able to use the standard method for computing the Virginia credit limitation.
CONCLUSION
Based on my review of the information provided, the Department's adjustment to the Taxpayers' credit for taxes paid to another state for the taxable year 2001 is correct. Accordingly, the assessment is upheld and your request for refund is denied.
The Code of Virginia sections, regulation and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact ***** in the Department's Office of Policy and Administration, Appeals and Rulings, at *****.
-
-
-
-
-
-
- Sincerely,
-
-
-
-
-
-
-
-
-
-
-
- Kenneth W. Thorson
Tax Commissioner
- Kenneth W. Thorson
-
-
-
-
-
AR/53379E
Rulings of the Tax Commissioner