April 3, 2018
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you appeal the individual income tax assessment issued to ***** (the “Taxpayer”) for the taxable year ended December 31, 2007. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayer, a resident of Virginia, was married to a nonresident member of the armed forces. For the 2007 taxable year, the couple filed a joint federal income tax return, and the Taxpayer filed a separate Virginia income tax return. The Taxpayer's spouse, a military service member, did not file a Virginia return because he had no income from Virginia sources. On her Virginia return, the Taxpayer claimed a deduction for the full amount of itemized deductions reported on the joint federal return, the full amount of child care expenses on which the federal credit was computed, and all of the couple's dependent exemptions. Under audit, the Department adjusted the Taxpayer's itemized deductions and exemptions to reflect her percentage of the couple's joint income and issued an assessment for additional tax and interest. The Taxpayer filed an appeal, contending the Department's apportioning of deductions and exemptions violates the provisions of the Servicemember's Civil Relief Act (SCRA), codified at 50 U.S.C. § 3901 et seq.
DETERMINATION
Virginia Code § 58.1-326 states, “if husband or wife is a resident and the other is a nonresident, separate taxes shall be determined on their separate Virginia taxable incomes on such single or separate forms as may be required by the Department, unless both elect to determine their joint Virginia taxable income as if both were residents.” [Emphasis added.]
In cases where a Virginia resident and nonresident spouse file separate state income tax returns, Virginia Code § 58.1-326 grants the Department authority to modify the allocation of exemptions and deductions claimed for federal income tax purposes under Virginia Code § 58.1-324. Title 23 of the Virginia Administrative Code (VAC) 10-110-190 B provides that each spouse must account separately for items of income, deductions, and exemptions. However, when such items cannot be accounted for separately, deductions and personal exemptions must be proportionally allocated between each spouse based upon the income attributable to each. See also Public Document (P.D.) 95-251 (9/29/1995).
Dependent Exemptions
The Taxpayer claimed all of the dependent exemptions reported on the joint federal return. When married taxpayers file a joint federal income tax return, but file separately for Virginia, Virginia Code § 58.1-324 C 5 provides:
Personal exemptions properly allowable for federal income tax purposes shall be allocated for Virginia income tax purposes as husband and wife may mutually agree; however, exemptions for taxpayer and spouse together with exemptions for old age and blindness must be allocated respectively to the spouse to whom they relate.
In P.D. 99-82 (4/21/1999), the Department ruled that when a spouse claims dependent exemptions on his/her separate state income tax return, such actions are considered by the Department to be separate accounting and evidence of a mutual agreement between the husband and wife. See also P.D. 10-199 (8/31/2010). In this case, the Taxpayer claimed the dependent exemptions on the Virginia return and it does not appear the husband claimed them on his state return.
Itemized Deductions
Pursuant to Virginia Code § 58.1-324, if a couple is unable to separately account for deductions and exemptions, they must be allocated proportionally between each spouse based on income attributable to each. See Title 23 VAC 10-110-190 B. Because the Taxpayer has not provided sufficient evidence of separate accounting for the itemized deductions, Title 23 VAC 10-110-190 B requires a proportional allocation of such deductions. See P. D. 11-180 (11/1/2011).
The Taxpayer has provided no evidence to show that she was solely responsible for paying for all of the itemized deductions claimed on the federal income tax return. Instead, she asserts the Department's allocation policy is prohibited by the SCRA. Specifically, 50 U.S.C. § 4001(e) prohibits a taxing jurisdiction from using military compensation of a nonresident service member to increase a tax liability imposed on such nonresident service member or their spouse. The Taxpayer argues the Department's policy is tantamount to an increase in the Virginia tax burden on a family based on a nonresident service member's military pay.
By reason of their character as legislative grants, statutes relating to deductions and subtractions 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). Further, in Lawrence Carr, Jr. v. W.H. Forst, Tax Commissioner of the Commonwealth of Virginia, 249 Va. 66, 453 S.E.2d 274 (1995), the Virginia Supreme Court stated that if a statute is clear and unambiguous, a court must accept its plain meaning and not resort to extrinsic evidence or rules of construction.
Consistent with Internal Revenue Service Revenue Ruling (Rev. Rul.) 71-268 (1971-1 CB 58), an itemized deduction is allowable under Title VAC 10-110-190 to the spouse who can account for the payment by demonstrating the payment was made out of his or her funds. However, if records are inadequate to facilitate such an accounting, the regulation requires an allocation of itemized deductions in proportion to income. The Department finds a proportionate determination to be fair, rational and equitable in the absence of separate accounting. See P.D. 95-251.
Contrary to the Taxpayer's claim that Virginia's regulation increases the Virginia tax liability as a result of using the service member spouse's income to compute allowable itemized deductions, Virginia's method is based squarely on federal law to which it conforms. See Virginia Code § 58.1-301.
Under the IRC, a deduction resulting from a payment of a joint obligation is allowable to whichever of the parties liable for such obligation actually makes the payment out of their own funds. See Al Jolson v. Comm'r, 3 T.C. 1184 (1944) and Mark B. Higgins v. Comm'r, 16 T.C. 140, 143-144 (1951). In P.D. 95-251, the Department expressed Virginia's conformity to the federal statutory regime with regard to itemized deductions. Further, where individuals have not been able to show clearly which spouse was entitled to a particular deduction, the deduction has been split between the husband and wife. See also Rev. Rul. 75-347 (1975-2 C.B. 70) and Priv. Ltr. Rul. 82-46-073 (Aug. 17, 1982). Instead of increasing the Taxpayer's tax liability based on the nonresident service member's compensation, the Department adjusted the deductions to which the Taxpayer is entitled for Virginia income tax purposes in the same manner it would for any married couple filing on separate returns in Virginia.
Further, the United States Supreme Court (the “Court”) has decided that a state may confine deductions in a manner as Virginia does. See Travis, Comptroller of the State of New York v. Yale & Towne Mfg. Co., 252 U.S. 60, 40 S. Ct. 228 (1920). In that case, the Court held that there is no unconstitutional discrimination against citizens of other states in confining the deductions of expense to such that are in connection with income arising from the taxing state.
Child and Dependent Care Deduction
Virginia Code § 58.1-322.03 3 (formerly § 58.1-322 D 3) provides a deduction for the cost of household and dependent care services necessary for gainful employment. A taxpayer may only claim the deduction if they were eligible to claim a credit for child and dependent care expenses under IRC § 21. The deduction is limited to the amount on which the federal credit is based.
Generally, a married couple may only claim the credit if they file a joint federal income tax return. See IRC § 21(e)(2). Here, the Taxpayer and her spouse filed a joint federal income tax return and would be eligible to claim a deduction pursuant to Virginia Code § 58.1-322.03 3. When a married couple files a joint federal return, but separate Virginia returns, the question becomes how to attribute the deduction to each spouse.
As indicated above, Virginia is permitted to allocate proportionally itemized deductions when a couple that files separate Virginia returns is unable to prove the deductions were accounted for separately. Such authority is based in part on federal treatment of these deductions in similar situations.
The statutory authority for Virginia's policy specifically addresses deductions properly taken for federal income tax purposes. The child and dependent care deduction, however, is not a deduction permitted for federal income tax purposes. Instead, employment-related expenses paid by the individual during a taxable year, subject to the certain limitations, are used to compute a credit directly against federal income tax.
Under IRC § 21(e)(4), a married couple filing separate federal returns would not be eligible to claim the credit unless one spouse maintained a household for more than one-half of the taxable year and incurred more than half the cost of maintaining such household and the other spouse was absent from the household during the last six months of the taxable year. Under such circumstances, the spouse who maintains the household may claim the credit. While circumstances similar to this could occur if a service member were deployed overseas, this would not generally be the situation with Virginia residents filing separately from their military spouses.
In the case of a divorce or separation, the custodial parent, as defined under IRC § 152(e)(4)(A), can take the credit if they have custody of a child who is under the age of 13 or is incapable of self-care for a longer period during the year than the noncustodial parent, even if such parent is not entitled to claim a dependency exemption. Again, this is not the situation with Virginia residents and their nonresident service member spouses. However, the federal rules clearly show a preference that only one parent may claim the credit when separate returns are filed. In this respect, the rules more similarly resemble federal and Virginia treatment of dependent exemptions.
Based on this analysis, the Department will allow a husband and wife to allocate the child and dependent care deduction as they mutually agree. For purposes of separate accounting, the Department will consider the act of claiming the deduction on a separate Virginia income tax return to be evidence of a mutual agreement between the husband and wife, provided a similar deduction or credit does not appear on the other spouse's state return. The full amount of the deduction was claimed by the Taxpayer on her Virginia return and it does not appear a similar deduction was reported by the husband on his state return.
CONCLUSION
Absent evidence of separate accounting, the Department's adjustment to the Taxpayer's itemized deductions is upheld. The Taxpayer, however, was entitled to claim both dependent exemptions and the full amount of the child and dependent care deduction on her Virginia income tax return. Accordingly, the assessment will be returned to the auditor to be adjusted in accordance with this determination and the enclosed schedule. A revised bill will be issued, and payment should be made within 30 days of the date of the revised bill to avoid the accrual of additional interest.
The Code of Virginia sections, regulations, and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/509.o