Tax Type
Individual Income Tax
Description
Subtractions from federal adjusted gross income; Foreign source income
Topic
Taxable Income
Date Issued
06-11-1997
June 11, 1997
Re: § 58.1-1821 Application: Individual Income Tax
Dear**************
This will respond to a letter from ********* your tax preparer, in which you seek correction of an individual income tax assessment for the taxable year 1992. I am addressing this letter to you because the department does not have a power of attorney from your tax preparer. I apologize for the delayed response.
FACTS
You were the subject of an office audit, and an adjustment was made to disallow a foreign source income subtraction. The department concluded that because foreign source interest, dividends, and other portfolio income was less than foreign source capital losses, there was no foreign source income included in federal adjusted gross income. You protest this adjustment, and contend that the department is without authority to require that foreign source capital losses be combined with other foreign source portfolio income for purposes of computing the Virginia foreign source income subtraction.
DETERMINATION
Code of Virginia § 58.1-301, copy enclosed, provides that the terms used in Virginia law as it relates to individual income taxation shall have the same meaning as terms used in the Internal Revenue Code. Accordingly, Virginia law provides that the starting point for computing Virginia taxable income is federal adjusted gross income with certain additions, subtractions, exemptions, and deduction modifications as specified in Code of Virginia § 58.1-322, copy enclosed.
Code of Virginia § 58.1-322(C)(7) provides that foreign source income, as defined in Code of Virginia § 58.1-302, may be subtracted on the Virginia return to the extent it is included in federal adjusted gross income. Code of Virginia § 58.1-302, copy enclosed, in pertinent part, provides that:
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- "Foreign source income" means interest, other than interest derived from sources within the United States; dividends, other than dividends derived from sources within the United States .... In determining the source of "foreign source income," the provisions of 861, 862, and 863 of the Internal Revenue Code (IRC) shall be applied ....
The provisions of IRC § 862(a) provides that certain foreign source income is subject to federal taxation. In addressing how expenses and losses are to be apportioned or allocated to such foreign source income in arriving at taxable income, IRC § 862(b) specifically provides that:
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- From the items of gross income specified in subsection (a) there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto, and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder. if any, shall be treated in full as taxable income from sources without the United States. (Emphasis added.)
As a result, capital losses, in conjunction with expenses and other deductions attributable to foreign source income, must clearly be deducted from foreign source income in computing the remaining income subject to federal taxation. To the extent that such remaining income is included in federal adjusted gross income, it may be subtracted on the Virginia return pursuant to Code of Virginia § 58.1-322(C)(7). Additionally, if applicable expenses, losses, or other deductions exceed foreign source income, there is no foreign source income remaining to subtract on the Virginia return. Notably, however, federal adjusted gross income would be reduced by the excess of these foreign expenses, losses, and deductions, over the foreign source income, which would cause a corresponding reduction in Virginia taxable income.
Code of Virginia § 58.1-322 (C)(7) formed the basis for the department's decision in Public Document (P.D.) 86-154, (8/14/86), copy enclosed. In this public document, the department stated "that the Virginia subtraction for foreign source income must be reduced by the expenses allowable in computing federal taxable income." While P.D. 86-154 addressed foreign source income subtractions for corporate income tax purposes, this ruling was also applicable to the individual income tax.
In the instant case, you received foreign source interest, dividends, other portfolio income, and capital losses that passed through to you from an S Corporation. Pursuant to IRC § 1366(b) and affirmed by the department in P.D. 88-165, copy enclosed, these items retained the same character to you as to the pass-through entity. In determining whether these items were included in federal adjusted gross income, it is necessary to determine their treatment on the corresponding federal return.
The foreign source interest, dividends, other portfolio income, and capital losses were reported on different schedules when computing the federal tax return, however, these items were included in federal adjusted gross income. Information provided by your tax preparer indicated that there were no capital losses carried forward to the taxable year 1993. As a result, 1992 capital losses, including the foreign source capital losses, were fully utilized to offset 1992 capital gains. These capital losses, therefore, were included in federal adjusted gross income. In the absence of the foreign source capital losses, the increased amount of net capital gains would have been subject to both federal and Virginia taxation.
Since you received the full benefit of these foreign source capital losses in determining federal adjusted gross income, they cannot be ignored in computing the Virginia foreign source income subtraction. As indicated by your tax preparer, the foreign source capital losses were used to offset capital gains. Consequently, the Virginia foreign source income subtraction must be reduced, to not less than zero, by the amount of foreign source capital losses.
Based on the information provided, there is no basis to allow the foreign source income subtraction that has not been reduced by the applicable foreign source capital losses. As a result, the department correctly issued an individual income tax assessment for the taxable year 1992. Please remit, within thirty days, the balance due of *** , which represents tax of ***and updated interest of *********. The payment should be remitted to********* , Office of Tax Policy, Department of Taxation, Post Office Box 1880, Richmond, Virginia 23218-1880. If you have any questions regarding this determination, you may call*******at ***** .
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/11248N
Rulings of the Tax Commissioner