Tax Type
Individual Income Tax
Description
Interest expenses on federal obligations
Topic
Taxable Income
Date Issued
12-10-1987
December 10, 1987
Re: Request for Ruling/Sales and Use Tax
Dear *****************
This will reply to your letter of April 30, 1987, in which you request a ruling on the application of the individual income tax to interest expense incurred to carry obligations of the United States.
FACTS
The taxpayer's taxable year 1985 federal income tax return indicates that interest expenses were incurred in order to carry obligations of the United States. The interest expenses were deducted by the taxpayer for federal and state income tax purposes, while the interest income from the taxpayer's United States obligations was exempt from the Virginia income tax by virtue of §58.1-322.C.1 of the Code of Virginia.
The taxpayer wishes to determine if the expenses incurred in carrying the nontaxable federal obligations must be added back to his federal adjusted gross income in order to determine Virginia taxable income.
RULING
Virginia Regulation 630-2-322.C.2.f provides:
-
- The subtraction for interest on exempt obligations must be reduced by any expenses attributable to such interest and by interest on indebtedness incurred or continued to purchase or carry exempt obligations pursuant to Internal Revenue Code §265.
- The subtraction for interest on exempt obligations must be reduced by any expenses attributable to such interest and by interest on indebtedness incurred or continued to purchase or carry exempt obligations pursuant to Internal Revenue Code §265.
Absent this regulatory provision, persons who borrowed funds on interest in order to obtain exempt federal obligations would receive a twofold state income tax benefit. First, they would be able to deduct the interest paid on the funds used to purchase the federal obligations and second, they would be able to deduct the interest income from the federal obligations when computing their Virginia income tax.
Further examination of the 1985 Consolidated Securities Account Statement provided by the taxpayer reveals, however, that the interest expense in question is not interest on indebtedness. Rather, the expense represents payments of interest to the seller on federal obligations purchased between interest payment dates. As such, the proper treatment of the interest expense on the taxpayer's federal return, pursuant to Internal Revenue Regulation §1.61-7(d), would have been to reduce the amount of interest income received by the amount of interest paid to the seller. In this case, however, the taxpayer claimed the interest expense as an itemized deduction.
§58.1-322.D.l.a of the Code of Virginia provides a deduction from federal adjusted gross income equal to "[t]he amount allowable for itemized deductions for federal income tax purposes where the taxpayer has elected for the taxable year to itemize deductions on his federal return." As the interest expense in question was not allowable as an itemized deduction for federal income tax purposes, it is not deductible for Virginia income tax purposes.
Based upon Internal Revenue Regulation §1.61-7(d) and §58.1-322.D.l.a of the Code of Virginia, the proper resolution of this matter will require the reduction of the taxpayer's federal adjusted gross income by the amount of interest paid the seller of the obligations. In addition, the taxpayer's itemized deductions and Virginia subtraction for interest on federal obligations should be reduced by the same amount. The reduction in the Virginia subtraction for interest on federal obligations would result in an increase of the taxpayer's Virginia taxable income.
Based upon these facts, I must conclude that the taxpayer will be required to increase his 1985 Virginia taxable income by an amount equal to the interest paid to the seller on federal obligations purchased between interest payment dates.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner