Could Virginia residents claim a 2006 credit for another state's tax on partnership income that was taxable there in 2005?

Subject

Income passed through from the Partnership was properly reported on State A return.

Plain-English summary

Virginia correctly denied the couple's other-state tax credit on their 2006 return because the partnership income was taxable in State A in 2005. The year they actually paid State A's 2005 liability did not move the credit into 2006.

Va. Code § 58.1-332 A was intended to relieve double taxation when qualifying income is taxed by Virginia and another state in the same taxable year. The allowable credit is limited to the statutory lesser amount and must be claimed for that common tax year.

The taxpayers still had a potential remedy: they were within the three-year refund period under Va. Code § 58.1-1823 and could amend their 2005 Virginia return to claim the credit. If they also received partnership income for 2006 and paid State A tax on that income, they could amend the 2006 return for the corresponding 2006 credit before the limitations period expired.

What this means for you

• Match an other-state credit to the year the same income was taxed by both states.
• A cash-basis taxpayer does not shift the credit merely because the other-state liability was paid the following year.
• If the credit was claimed on the wrong Virginia return, check whether the correct year's refund deadline is still open.
• Preserve the other-state return and records showing the income and tax attributable to that year.

Common questions

Q: Why did Virginia reject the credit on the 2006 return?
A: The State A tax related to partnership income reported for 2005, so the corresponding Virginia credit belonged on the 2005 return.

Q: Did paying the State A tax in 2006 make it a 2006 credit?
A: No. The ruling tied the credit to the year of double taxation, not the payment date.

Q: Was the credit permanently lost?
A: Not necessarily. The taxpayers could file an amended 2005 Virginia return within the refund limitations period.

Citations and references

• Va. Code §§ 58.1-332 A and 58.1-1823.
• P.D. 94-321 and P.D. 05-88.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-70

Original ruling text

May 23, 2008

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the Department's disallowance of the out-of-state tax credit claimed on the 2006 Virginia individual income tax return filed by * (the "Taxpayers").

FACTS

The Taxpayers, a husband and wife, are Virginia residents who received income from a jointly owned partnership (the "Partnership") located in * ("State A"). The Taxpayers filed a State A individual income tax return for the 2005 taxable year and paid the resulting State A income tax liability during 2006. On their 2006 Virginia individual income tax return, the Taxpayers claimed a credit for taxes paid to other states (the "out-of­ state tax credit") for the amount of the 2005 State A income tax liability paid in 2006.

Under a review by the Department, the out-of-state tax credit was disallowed because the Partnership's income was not subject to income taxation by both State A and Virginia for the 2006 taxable year. As a result, the Department reduced the Taxpayers' refund.

The Taxpayers contest this adjustment to their refund, asserting that as cash basis taxpayers they should be entitled to an out-of-state tax credit for taxes paid to State A during 2006.

DETERMINATION

Virginia Code § 58.1-332 A allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or on any gain from the sale of a capital asset. The intent of the credit is to grant Virginia residents relief in situations where they are taxed by both Virginia and another state on these types of income during the same taxable year. The credit is claimed on the income tax return for the same taxable year in which the income is subject to taxation by another state, even though the tax is actually paid during the succeeding taxable year when the return is filed.

The amount of credit for taxes paid to other states is limited to the lesser of (i) the tax actually paid to another state on income sourced outside Virginia, or (ii) the amount of tax actually paid to another state that is equivalent to the proportion of income taxable in such state to Virginia taxable income. As such, Va. Code § 58.1-332 only provides relief for qualified income that is taxed by Virginia and another state in the same taxable year. See Public Document (P.D.) 94-321 (10/21/1994) and P.D. 05-88 (06/09/2005). In situations where the tax is paid to another state and Virginia in a different taxable year, Virginia law provides no relief.

In this case, the income passed through from the Partnership was properly reported on the Taxpayers' 2005 State A income tax return. In addition, the tax was properly paid to State A for the 2005 taxable year during 2006. Based on Virginia law, an out-of-state credit for the tax paid to State A for the 2005 taxable year could be claimed for a 2005 Virginia return. Accordingly, the credit claimed on the Taxpayers' 2006 Virginia income tax return was correctly disallowed.

Pursuant to Va. Code § 58.1-1823, an amended return claiming a refund may be filed within three years from the last day prescribed by law for the timely filing of the return. As such, the Taxpayers are within the statute of limitations to file an amended 2005 Virginia individual income tax return to claim an out-of-state tax credit for taxes paid to State A for the 2005 taxable year. Likewise, if the Taxpayers received any pass through income from the Partnership for the 2006 taxable year, they may amend their 2006 Virginia individual income tax return to claim an out-of-state tax credit for taxes paid on their State A income tax return. The amended returns must be filed before the expiration of the statute of limitations.

The Code of Virginia sections and public documents cited, along with other reference documents, are available on-line www.tax.virginia.gov in the Tax Policy Library 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,

Janie E. Bowen

Tax Commissioner

AR/1-2077192148.O