Could Virginia allocate itemized deductions by income when a resident spouse filed separately from a nonresident service member?

Subject

Untraced itemized deductions were allocated between resident and nonresident spouses by income

Plain-English summary

Virginia upheld an income-based allocation of itemized deductions because the resident spouse did not separately trace the payments to her own funds. She filed a separate 2006 Virginia return after filing jointly for federal purposes with a nonresident active-duty spouse who had no Virginia-source income.

When resident and nonresident spouses do not elect to calculate joint Virginia income as if both were residents, each spouse must separately account for income, deductions, and exemptions. If the items cannot be separately identified, the regulation allocates deductions and personal exemptions proportionally according to each spouse's income.

The taxpayer argued that using military pay in that calculation improperly increased her Virginia liability under the Servicemembers Civil Relief Act. Virginia disagreed. It treated the allocation as a rational method for dividing deductions when payment records were inadequate, not as taxation of the nonresident service member's compensation.

The assessment remained due. The ruling separately noted that federal law changed effective for 2009 and later regarding when a spouse accompanying a service member can gain or lose domicile.

What this means for you

• A joint federal return can require separate Virginia accounting when only one spouse is a resident.
• The spouse who claims a deduction should retain evidence showing payment from that spouse's funds.
• Without adequate tracing, Virginia can divide deductions based on the spouses' income.
• This ruling applied 2006 law and flags a federal military-spouse change for 2009 onward.

Common questions

Why were the deductions allocated by income?

The taxpayer did not provide adequate records separately identifying who paid them.

Did the allocation tax the service member's income?

Virginia said no; the compensation was used to divide deductions, not included as Virginia taxable income.

Was relief granted?

No. The assessment was upheld.

Citations and references

• Va. Code § 58.1-326.
• 23 VAC 10-110-190(B).
• 50 U.S.C. § 571(d), as cited in the ruling.
• IRS Revenue Ruling 71-268.
• Virginia Public Document 95-251 and Virginia Tax Bulletin 9-10.
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (1983).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-23

Original ruling text

March 26, 2010

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 assessment issued to * (the "Taxpayer") for the taxable year ended December 31, 2006. I apologize for the delay in the Department's response.

FACTS

The Taxpayer, a resident of Virginia, was married to a nonresident member of the armed forces. For the 2006 taxable year, the couple filed a joint federal income tax return and the Taxpayer filed a separate Virginia income tax return. The spouse did not file a Virginia return because he had no income from Virginia sources.

The Department reviewed the Taxpayer's allocation of itemized deductions between the Taxpayer and the spouse reported on the Virginia return. As a result of this review, the itemized deductions were adjusted proportionally according to income and an assessment was issued. The Taxpayer appeals the assessment, contending that the Department's adjustment increases the Taxpayer's Virginia income tax liability in violation of the Servicemembers Civil Relief Act.

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.) When a resident/nonresident married couple do not elect to determine their Virginia taxable income as if both were residents, Title 23 of the Virginia Administrative Code (VAC) 10-110-190 B provides:

In the case of a married couple, one of whom is a nonresident of Virginia filing separately, each spouse must account separately for items of income deductions, and exemptions. Where such items cannot be accounted for separately, deductions and personal exemptions must be proportionally allocated between each spouse based upon income attributable to each. (Emphasis added.)

The Taxpayer asserts that the Department lacked authority to adjust her itemized deductions because the spouse's military pay was used to proportionally adjust the deductions. Under the Servicemembers Civil Relief Act (50 U.S.C. § 571), a state may not tax the income of a member of the armed services who maintains his or her domicile in another state. Specifically, 50 U.S.C. § 571 (d) states:

A tax jurisdiction may not use the military compensation of a nonresident service member to increase the tax liability imposed on other income earned by the nonresident service member or spouse subject to tax by the jurisdiction

According to the Taxpayer, the Department's policy, as it is applied in this case, is tantamount to an increase in Virginia taxability based on a nonresident individual's military pay.

By reason of their character as legislative grants, however, 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).

Consistent with Internal Revenue Service Revenue Ruling (Rev. Rul.) 71-268, 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 Public Document (P.D.) 95-251 (9/29/1995).

Based on the foregoing, the Department's adjustments to the Taxpayer's 2006 Virginia income tax return are correct, and the Taxpayer's application for relief is denied. Accordingly, the assessment is upheld and is now due and payable. An updated bill notice will be issued shortly to the Taxpayer.

Please note that the Servicemembers Civil Relief Act was amended, effective for 2009 taxable year and thereafter, to provide that a spouse can neither lose nor acquire domicile or residence in a state when the spouse is present in the state solely to be with the servicemember in compliance with the servicemember's military orders if the residence or domicile is the same for both the servicemember and spouse. See Tax Bulletin (VTB) 9-10 (11/12/2009) for more information on this change.

The Code of Virginia and regulation sections, and the public document cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department of Taxation's web site. If you have any questions about this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

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