March 15, 2021
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the individual income tax assessments issued to ***** (the “Taxpayers”) for the taxable years ended December 31, 2017 and 2018.
FACTS
The Taxpayers, a husband and a wife, filed joint Virginia resident income tax returns for the 2017 and 2018 taxable years, claiming credits for income tax paid to other states. A portion of the credits claimed on their Virginia returns was attributable to income tax paid to ***** (State A), a state where the Taxpayers also filed resident returns for the taxable years at issue. Under review, the Department denied the credits and issued assessments. The Taxpayers appeal, contending that they properly claimed the credits in accordance with Virginia law.
DETERMINATION
Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state provided the income is either earned or business income. Virginia law does not necessarily 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 the amount of tax actually paid to the other state or the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state. See Public Document (P.D.) 97-301 (7/7/1997). The credit is also subject to the further limitation that the income upon which the credit may be claimed must be “derived from sources outside the Commonwealth” and otherwise subject to Virginia income tax. See Virginia Code § 58.1-332 A. Thus, a Virginia resident taxpayer may not claim credit on their Virginia income tax return for income tax paid to another state on Virginia source income.
The assessments that the Department issued arose out of Virginia resident income tax returns the Taxpayers filed. It appears that the Department denied the credits on two bases: 1) that the Taxpayers had not proven that they were domiciliary residents of Virginia entitled to claim the credits; and 2) that the Taxpayers were improperly “double dipping” by claiming credits for income tax paid to other states on both their State A and Virginia returns.
The Taxpayers assert they were domiciliary residents of Virginia for the 2017 and 2018 taxable years and indicated their intent by filing resident returns. It does not appear that the Department made a formal inquiry or determination as to the Taxpayers’ residency status. Further, despite having return information from other states, the reviewers failed to make any attempt to determine a nonresident apportionment ratio that would be required if the Taxpayers were deemed nonresidents. When the Department initiates a change of residency on a taxpayer’s return, it must consider all of the statutory requirements for filing a return under the new residency status and make all necessary adjustments based on the information available.
The fact that the Taxpayers claimed credits on both their Virginia and State A returns does not necessarily mean that the Taxpayers could not claim them on their Virginia returns. The following simplified example illustrates credits for taxes paid to other states when a taxpayer is a domiciliary resident of one state and an actual resident of another state (commonly called “dual residency”).
Assume taxpayer is a resident of both Virginia and State B. For simplicity, also assume that the taxpayer filed nonresident returns in States C and D in which only her State C and D source income was subject to tax. In addition, assume that all the state’s tax uniformity at a 5% rate:
|
Income |
|
|
Virginia Source Income |
$100 |
|
State B Source Income |
$200 |
|
State C Source Income |
$200 |
|
State D Source Income |
$300 |
|
No State Source |
$200 |
|
Total Income |
$1000 |
|
Virgina Resident Return |
|
|
Total Income |
$1000 |
|
Total Virginia Tax |
$50 |
|
Less State B Credit |
($10) |
|
Less State C Credit |
($10) |
|
Less State D Credit |
($15) |
|
Payable Virginia Tax |
$15 |
|
State B Resident Return |
|
|
Total Income |
$1000 |
|
Total State B Tax |
$50 |
|
Less State A Credit |
($15) |
|
Less State C Credit |
($10) |
|
Less State D Credit |
($15) |
|
Payable State B Tax |
$10 |
In this simplified example, if the taxpayer had $1000 of income and no credit available from any other state, she would have owed $50 in State A tax. Taking into account the other state income for which she could claim credits for tax paid, she would be left with $100 of State A source income plus $200 of income not otherwise subject to a credit, for a payable tax of $15 on that $300 amount of income. Next, consider the State B return.
The final result is that the taxpayer paid $15 to State A, $10 to State B, $10 to State C and $15 to State D, for a total of $50 tax paid to all states. This was the same amount of tax that would have been due had all the income simply been subject to tax in State A without any credits. This example illustrates, therefore, that “double dipping” of credits in a dual residency scenario does not necessarily occur when a taxpayer claims credit for tax paid to one resident state on the other resident state’s return or when the taxpayer claims the same credit for tax paid to nonresident states on both resident returns.
When taxpayers are dual residents, Virginia Code § 58.1-332 does not prohibit taxpayers from claiming a credit for income tax paid to the other state on their Virginia return. See P.D. 16-41 (3/31/2016). The statute also does not prohibit a taxpayer from claiming a credit for income tax paid to nonresident states on both resident state returns. If a taxpayer was required to pay income tax on a nonresident’s state source income, then in determining whether that tax qualified for a Virginia resident credit under Virginia Code § 58.1-332, whether the taxpayer claimed that credit on another state’s resident return is irrelevant. The credit, however, is subject to certain limitations described in Virginia Code § 58.1-332, including that the income upon which the credit may be claimed must be “derived from sources outside the Commonwealth” and otherwise subject to Virginia income tax.
With their appeal, the Taxpayers have provided pro forma nonresident returns for both Virginia and State A to demonstrate the amount of credits they claimed that were attributable to each state on the other state’s resident return. This breakdown of income by source is consistent with the instruction the Department gave the dual resident taxpayers in P.D. 16-41 and demonstrates that they have not attempted to claim a credit for income tax paid to State A on any income from Virginia sources.
The case, therefore, will be returned to the reviewer in order to reinstate the credits consistent with this determination and adjust the assessments accordingly. If a review of the Taxpayers’ specific computations has not already been conducted, the unit may perform such a review and make any adjustments to the credits that the review would warrant. If any such adjustments are made, the basis for them must be clearly communicated to the Taxpayers. At that point, if any balances remain due on the assessments, the Taxpayers will have 90 days from the date revised bills are issued in which to appeal any further adjustments that were made.
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/3464.M