September 14, 2016
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek a refund of individual income tax paid by ***** (the “Taxpayer”) for the taxable year ended December 31, 2015.
FACTS
The Taxpayer reported an amount of income on his 2014 federal and Virginia income tax returns that he was subsequently required to repay in 2015. On his 2015 federal and Virginia income tax returns, the Taxpayer claimed credit for the amount of tax that was attributable to the inclusion of such amount in income on his 2014 returns. Under review, the Department denied the credit. As a result, the Taxpayer's refund was reduced. The Taxpayer appeals, contending that under the claim of right doctrine, he was permitted to claim a credit for the amount of tax that was attributable to the amount of income he reported on his 2014 Virginia return but had to repay in 2015.
DETERMINATION
Virginia Code § 58.1-301 provides that 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. For individual income tax purposes, Virginia conforms to federal law in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). See Va. Code § 58.1-322 A.
The claim of right doctrine, as it has been established as a principle of tax law, provides that payments must be included in gross income if the taxpayer receives them without restriction under a claim of right. This is true even though the taxpayer may discover in a later year that he had no right to the payments and is required to repay the same amount. Under the claim of right doctrine, the taxpayer may deduct the repayments in the year in which they are made.
When the repayments exceed the income for the year of the repayment or when the income (after the subtraction of the repayments) is taxed at a rate lower than that at which the income was taxed in the year of inclusion, the deduction does not compensate the taxpayer adequately for the tax that was originally paid on the inclusion of the income. IRC § 1341 provides a mechanism by which this inequity is corrected in cases in which the repayment exceeds $3,000.
Under the provisions of IRC § 1341, a taxpayer is allowed to either: (1) reduce the tax for the year of the repayment by the amount of tax attributable to the inclusion of the income in the previous year(s), or (2) deduct the amount repaid in the year of the repayment. The taxpayer is allowed to use whichever method results in the lower tax liability. In either case, the adjustment is made to the return for the year of the repayment, not to the prior year's return in which the income was included.
In order to maintain conformity with the options available to individuals under the IRC, the Department allows individuals to fully follow the provisions of IRC § 1341 for Virginia income tax purposes. See Public Document (P.D.) 87-190 (8/5/1987). This means that the method elected for federal income tax purposes under IRC § 1341, to account for the repayment, determines which method must be used for Virginia income tax purposes.
When an individual chooses to reduce the tax for the year of the repayment by the amount to tax attributable to the inclusion of the income in the previous year(s), a schedule must be attached to the Virginia return detailing the computation of the Virginia tax consequences of the repayment. In addition, a copy of the schedule attached to the federal return, used to compute the federal tax consequences of the repayment, must also be attached to the Virginia return. The amount of tax benefit derived from the repayment must be included on the line of the Virginia return designated for Virginia income tax withheld.
In this case, the Taxpayer chose to claim a credit on his 2015 Virginia return for the amount of tax that was attributable to the amount of income he reported on his 2014 federal and Virginia returns but had to repay in 2015. The Taxpayer also included a schedule showing the computation of the credit and properly reported it as an additional withholding credit. As such, the credit will be allowed and a refund issued, as warranted.
The Taxpayer should be aware, however, that unlike other Virginia credits, the claim of right doctrine is directly tied to IRC treatment. Thus, if the Internal Revenue Service (IRS) changes the claim amount, the Taxpayer will also have the responsibility to file an amended return within one year of such change in order to adjust his Virginia claim accordingly. See Va. Code § 58.1-311.
The Code of Virginia sections and public document 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/1-6312409633.M