Document Number
08-102
Tax Type
Individual Income Tax
Description
Foreign source income passed through to the Taxpayers by a Subchapter S corporation
Topic
Computation of Income
Constitutional Provisions
Corporate Distributions and Adjustments
Date Issued
06-18-2008



June 18, 2008








Re: Request for a Ruling: Individual Income Tax

Dear *****:

This will reply to your letter in which you request a ruling as to whether your clients, ***** (the "Taxpayers"), may subtract foreign source income passed through from a Subchapter S corporation.

FACTS


For taxable year 2006, the Taxpayers filed a Virginia individual income tax return on which they claimed a foreign source income subtraction. The foreign source income was passed through to the Taxpayers by a Subchapter S corporation ("S corporation"). This subtraction was subsequently disallowed by the Department on the basis that the foreign source income subtraction for individuals was repealed in 2003.

The Taxpayers contend, however, that a strict reading of the Code of Virginia can be interpreted as supporting the Taxpayers' subtraction of the S corporation's foreign source income. They seek a ruling as to whether they may subtract foreign source income that flowed through from an S corporation.

RULING


For many years, Virginia provided a foreign source income subtraction to individual income taxpayers. However, the General Assembly repealed the subtraction, formerly Va. Code § 58.1-322 C 7, effective for taxable years beginning on and after January 1, 2003. See Chapter 980, 2003 Acts of Assembly.

Virginia Code § 58.1-402 C 8 provides a subtraction to corporations for foreign source income as defined in Va. Code § 58.1-302 to the extent such income is included in federal taxable income. The Taxpayers believe that a strict reading of Virginia statutes supports the subtraction for foreign source income claimed by individuals if it is passed through from an S corporation.

The Taxpayers argue that S corporations are specifically included in the definition of "foreign source income." Virginia Code § 58.1-302 defines "foreign source income" as:
    • The amount of an individual's share of net income attributable to a foreign source qualified business unit of an electing small business corporation (S corporation). For purposes of this subsection, qualified business unit shall be defined by § 989 of the Internal Revenue Code, and the source of such income shall be determined in accordance with §§ 861, 862 and 987 of the Internal Revenue Code.

The Taxpayers believe that, because the S corporation in which they are shareholders is a qualified business unit under Internal Revenue Code (IRC) § 989 and its source of the income falls within IRC § 861 et seq., they are entitled to a foreign source income subtraction.

By reason of their character as legislative grants, statutes relating to deductions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell's Motor Freight, Inc., et al. v. Virginia Department of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983). Accordingly, the fact that the income from an S corporation is defined as foreign source income or such S corporation is a qualified business unit under IRC § 989 does not mean such income can be subtracted without statutory authority enabling such a subtraction.

Virginia Code § 58.1-401 exempts "electing small business corporations" from Virginia corporation income tax. As a result, S corporations are not subject to tax in Virginia. Instead, the income of such corporations is taxed to the shareholders upon distribution. Effective for taxable years beginning on and after January 1, 2004, all pass­through entities, including S corporations, are required to file an annual information return with the Department setting forth their income and a list of their owners. See Chapter 3, Acts of Assembly, 2004 Special Session I. Specifically, Virginia Code § 58.1-391 A provides:
    • In determining Virginia taxable income of an owner, any modification described in § 58.1-322 that relates to an item of pass-through entity income, gain, loss or deduction shall be made in accordance with the owner's distributive share, for federal income tax purposes, of the item to which the modification relates. [Emphasis added.]

Under this statute, any subtraction available under Va. Code § 58.1-322 will flow through from a pass-through entity to an individual taxpayer, who in turn could take the subtraction on his or her Virginia individual income tax return. The statute, however, limits the type of subtraction modifications passed through from S corporations to those permitted under Va. Code § 58.1-322. As such, even though Virginia statutes permit corporations a subtraction for foreign source income, an S corporation is prohibited from reporting the foreign source income subtraction on their Virginia pass-through entity return and the schedule (Form VK-1) that reports a taxpayer's portion of the subtraction.

The Taxpayers contend that the Code of Virginia permits subtractions to individual income taxpayers that are not enumerated in Va. Code § 58.1-322. They specifically cite Va. Code § 58.1-513 D, which allows for a subtraction for gain recognized by a taxpayer when a transfer of a credit taken pursuant to the Virginia Land Conservation Incentives Act of 1999 occurs.

It is true that the Code of Virginia includes statutes other than Va. Code § 58.1-322 that grant subtractions to individual taxpayers. None of those other statutes, however, replaces the foreign source income subtraction for individuals that was repealed by the General Assembly in 2003.

Under the rules of strict construction, the Department correctly disallowed the Taxpayers' subtraction that flowed through from the S corporation for the 2006 taxable year, regardless of the fact that the income that they receive is defined as foreign source income pursuant to Va. Code § 58.1-302.

This ruling is based on the facts provided as summarized above. Any change in facts or the introduction of new facts may lead to a different result.

The Code of Virginia sections 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 ruling, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****.
                • Sincerely,

                • Janie E. Bowen
                  Tax Commissioner



AR/1-2146595261.B

Rulings of the Tax Commissioner

Last Updated 08/25/2014 16:46