Could shareholders claim a recycling-equipment credit earned by a corporation in 2004 and later carried into its S-corporation years?

Subject

Timing gap barred 2004 recycling credit passed through to shareholders

Plain-English summary

Virginia denied the portion of a recycling-machinery credit earned by the corporation in 2004 because individuals were not eligible for that pass-through credit in the relevant years. The corporation had earned credits in 2001, 2003, and 2004 before later electing S-corporation treatment.

The individual version of the credit had expired after the 2003 tax year. Separate legislation did not permit corporate recycling credits to pass through to individuals until tax years beginning in 2008.

Virginia allowed the couple's shares of carryforwards earned in 2001 and 2003 because those years fell within the individual credit's active period. The 2004 credit fell into the gap: earned after individual eligibility expired and before pass-through claims were authorized.

The Department therefore upheld the 2005 assessment and denied a refund for the 2004-earned portion.

What this means for you

• Credit eligibility can depend on the year the credit was earned, not only the year claimed.
• A later S-corporation election does not necessarily change the original credit's character or eligibility.
• Carryforward rules do not cure a statutory gap in who may claim the credit.
• Historical sunset and effective dates must be checked year by year.

Common questions

Which credit years were allowed?

2001 and 2003.

Which year was denied?

The credit earned in 2004.

When did Virginia permit this pass-through to individuals?

For tax years beginning on or after January 1, 2008.

Citations and references

• Former Va. Code §§ 58.1-338 and 58.1-445.1.
• Va. Code §§ 58.1-439.7 and 58.1-439.8.
• 1990 Va. Acts ch. 709; 2001 Va. Acts ch. 91; 1998 Va. Acts ch. 253; and 2007 Va. Acts chs. 529 and 593.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-45

Original ruling text

May 5, 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 your clients, * (the "Taxpayers"), for the taxable year ended December 31, 2005. I apologize for the delay in the Department's response.

FACTS

The Taxpayers, a husband and wife, claimed a tax credit for the purchase of machinery and equipment for processing recyclable material (the "Credit") on their 2005 Virginia income tax return. The Credit was earned in 2004 by a corporation that later elected by be treated as an S corporation. The Credit was passed through to the Taxpayers from an S corporation.

The Department disallowed a portion of the Credit that was earned by the S corporation during the 2004 taxable year. An assessment for additional tax and interest was issued. The Taxpayers paid the assessment, but filed an appeal contending that the statute permits the Credit to be claimed by individuals when received from a pass-through entity.

DETERMINATION

In 1990, the General Assembly enacted the Credit. See Chapter 709, 1990 Acts of Assembly . Under this chapter, the Credit was permitted for individual income taxpayers under Va. Code § 58.1-338 and for corporate income taxpayers under Va. Code § 58.1-445.1.

The Credit for both individuals and corporations included a sunset provision that was extended several times by the General Assembly. For the individual income tax credit, Va. Code § 58.1-338 was last extended through taxable years beginning before January 1, 2004 (Chapter 91, 2001 Acts of Assembly ). Thus, the Credit for individual income taxpayers expired after the 2003 taxable year.

In 1998, the General Assembly (Chapter 253, 1998 Acts of Assembly ) repealed and reenacted the Credit for corporations under Va. Code §§ 58.1-439.7 and 58.1­-439.8. In 2007, the General Assembly enacted legislation (Chapters 529 and 593, 2007 Acts of Assembly ) to permit, the credit to be passed through to individuals for taxable years beginning on or after January 1, 2008.

In this case, a corporation, earned the Credit in 2001, 2003, and 2004 when it was a taxable entity and carried the Credit forward into a taxable year in which it elected to be treated as an S corporation. The Taxpayers received their proportionate share of the Credit carryforward. The Taxpayers were granted the Credit carried forward from 2001 and 2003 as permitted by the statute. However, because the corporation earned the Credit after its 2003 taxable year and individuals were not permitted to claim Credits earned by pass-through entities until the 2008 taxable year, the Department properly denied the 2004 Credit carryforward on the Taxpayers' 2005 return. Accordingly the assessment for the 2005 taxable year is upheld and no refund will be issued.

The Code of Virginia sections cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's website. If you have questions concerning this determination, you may contact * at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-3534200880.D