Could a Virginia resident filing separately claim dependent exemptions allocated by agreement with a nonresident servicemember spouse?

Subject

Servicemembers Civil Relief Act

Plain-English summary

The Virginia resident spouse could claim the dependent exemptions that the couple mutually allocated to her separate Virginia return. Virginia law did not require both spouses to have Virginia taxable income before they could agree on that allocation.

Proportional allocation applies when spouses cannot separately account for exemptions. Here, the spouses had agreed to assign the dependent exemptions to the resident spouse, so the Department restored them and issued a refund after the paid assessment was adjusted.

The ruling separately discussed itemized deductions and the Servicemembers Civil Relief Act. It said a spouse should substantiate deductions paid from that spouse's own funds; when records are inadequate, Virginia's regulation calls for allocation in proportion to income. The conclusion granted relief by restoring dependent exemptions and did not announce a broader holding that all proportional allocation involving military pay violated the Act.

What this means for you

• Spouses filing separate Virginia returns could mutually allocate dependent exemptions allowed federally.
• Exemptions tied specifically to the taxpayer, spouse, age, or blindness remained allocated to the person to whom they related.
• Proportional allocation was unnecessary when the couple could separately account for dependent exemptions.
• Separate documentation remained important for itemized deductions.

Common questions

Did the nonresident servicemember need Virginia taxable income before the spouses could agree on dependent exemptions?

No. The Department said the statute imposed no such requirement.

What relief did the Department actually order?

It restored the resident spouse's dependent exemptions and refunded the resulting overpayment.

Citations and references

• Va. Code §§ 58.1-326 and 58.1-324(C)(5).
• 23 VAC 10-110-170 and 23 VAC 10-110-190(B).
• 50 U.S.C. § 571(d).
• P.D. 03-20, P.D. 10-199, and P.D. 95-251, cited in the ruling.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-273

Original ruling text

December 16, 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 servicemember in 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 servicemember did not file Virginia returns because he had no income from Virginia sources.

Under review, the Department adjusted the itemized deductions and dependent exemptions claimed proportionally according to the couple's joint income. As a result, the Department issued an assessment for additional tax and interest because the Taxpayer did not provide documentation showing that the itemized deductions or personal deductions were accounted for separately.

The Taxpayer appeals the assessments, contending that Virginia law permits married taxpayers filing separate returns to allocate dependent exemptions as mutually agreed. Further, the Taxpayer contends that the adjustments increased the Taxpayer's Virginia income tax liability in violation of the Servicemembers Civil Relief Act.

DETERMINATION

Virginia Code § 58.1-326 slates, "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."

Dependent Exemptions

The Taxpayer asserts that Title 23 of the Virginia Administrative Code (VAC) 10-110-170 provides that the Taxpayer and spouse may allocate the dependent exemptions allowed for federal purposes on the Virginia return as mutually agreed. Further, the Taxpayer asserts that the decision to allocate all the dependent exemptions to the wife's separate return was mutually agreed.

If a joint federal income tax return is filed and each spouse is a domiciliary or actual resident of a different state, the couple is not required to file a joint Virginia individual income tax return. Instead, each spouse with income subject to Virginia income taxation may file a separate Virginia return. In such circumstances, Title 23 VAC 10-110-190 B provides that personal exemptions must be accounted for separately by each spouse. If the couple is unable to separately account for these exemptions, they must be allocated proportionately between each spouse based on income attributable to each.

It should be pointed out that allocating exemptions proportionately is only done when a married couple is unable to separately account for dependent exemptions. When such is the case, Public Document (P.D.) 03-20 (3/20/2003) prescribes the appropriate method for determining how many dependent exemptions would be attributed to each spouse.

When married taxpayers file a joint federal income tax return, but file separately for Virginia, Va. Code § 58.1-324 C 5 provides:

Personal exemptions properly allowable for federal income tax purposes shall be allocated for Virginia income tax purposes as husband and wife may mutually agree; however, exemptions for taxpayer and spouse together with exemptions for old age and blindness must be allocated respectively to the spouse to whom they relate.

Virginia Code § 58.1-324 does not specify that both spouses must have Virginia taxable income in order to allocate personal exemptions as the husband and wife mutually agree. In this case, the Taxpayer and the spouse mutually agreed to allow the Taxpayer to claim the dependent exemptions on her 2006 income tax returns. Because they were able to separately account for their dependent exemptions, proportional allocation under Title 23 VAC 10-110-190 B was not required. Also see P.D. 10-199 (8/31/2010).

Servicemembers Civil Relief Act

The Taxpayer asserts that the Department lacked authority to adjust the itemized deductions and personal exemptions 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 (10/2-7/1983).

Consistent with Rev. Rul. 71-268, an itemized deduction is allowable under Title 23 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 P.D. 95-251 (9/29/1995).

CONCLUSION

Based on the foregoing, they Taxpayer's 2006 Virginia income tax return will be returned to the auditor so that the Taxpayer's allocation of dependent exemptions may be restored. Because the assessment has been paid, the adjustment will result in a refund.

The Code of Virginia sections, regulations, and the public documents 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 Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Linda D. Foster

Deputy Tax Commissioner

AR/1-4414449352.E