Could Virginia include a nonresident servicemember spouse's federally excluded combat pay when allocating joint itemized deductions?

Plain-English summary

Virginia ruled that federally excluded combat pay could not be included in the proportional allocation of joint itemized deductions. The Virginia resident and nonresident servicemember filed jointly for federal purposes but separately for Virginia purposes.

When deductions cannot be separately accounted for, Virginia allocates them between spouses based on the income attributable to each. The ruling treated federal adjusted gross income as the proper base.

The Department had included the servicemember's combat pay even though it was excluded from FAGI. That was inconsistent with P.D. 11-170. Because the taxpayer had already paid the assessment, Virginia directed an audit adjustment and a refund with applicable interest.

What this means for you

• Joint deductions may be allocated when spouses file separate state returns and cannot trace the items separately.
• The allocation base was FAGI under the ruling.
• Federally excluded combat pay could not inflate that base.
• The final refund amount depended on the auditor's revised calculation.

Common questions

Q: Did Virginia eliminate proportional allocation?
A: No. It corrected the income included in the ratio.

Q: Was a refund ordered?
A: Yes. The paid assessment was to be revised and refunded with applicable interest.

Citations and references

• Va. Code §§ 58.1-322, 58.1-324, and 58.1-326.
• 23 VAC 10-110-190(B).
• Virginia Public Documents 95-251 (September 29, 1995) and 11-170 (September 29, 2011).

Subject

Combat pay excluded from FAGI and computation when proportionally allocating itemized deductions

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-189

Original ruling text

November 30, 2011

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 client, * (the "Taxpayer"), for the taxable year ended December 31, 2007. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer, a resident of Virginia, is married to a member of the armed forces. For the 2007 taxable year, the couple filed a joint federal income tax return, and the Taxpayer filed a separate Virginia income tax return. The Taxpayer's spouse, who is not a resident of Virginia, did not file a Virginia individual income tax return because he had no income from Virginia sources.

Under review, the Department adjusted the Taxpayer's itemized deductions based on her proportion of the couple's income. The Taxpayer satisfied the assessment but appeals the inclusion of the service member's combat pay in the proportional allocation computation.

DETERMINATION

In cases where a Virginia resident and nonresident spouse file separate state income tax returns, Virginia Code § 58.1-326 grants the Department authority to modify the allocation of exemptions and deductions claimed for federal income tax purposes under Va. Code § 58.1-324. Title 23 of the Virginia Administrative Code (VAC) 10-110-190 B provides that each spouse must account separately for items of income, deductions, and exemptions. However, when such items cannot be accounted for separately, deductions and personal exemptions must be proportionally allocated between each spouse based upon the income attributable to each. See also Public Document (P.D.) 95-251 (9/29/1995).

In P.D. 11-170 (9/29/2011) the Tax Commissioner ruled that the apportionment computation for a resident taxpayer is based on his or her federal adjusted gross income (FAGI). Pursuant to Va. Code § 58.1-322, Virginia starts with the FAGI, requires certain additions, and permits certain deductions and subtractions in computing Virginia taxable income. Accordingly, the Department considers it rational to apportion deductions and exemptions between a husband and wife under Va. Code § 58.1-326 based on FAGI.

In accordance with P.D. 11-170, combat pay excluded from FAGI should also be excluded from the computation when proportionally allocating itemized deductions. In this case, the Department included the spouse's combat pay in the allocation computation. Such methodology is not consistent with P.D 11-170. Therefore, the assessment will be returned to the auditor to be adjusted in accordance with this determination and P.D. 11-170. A refund, including applicable interest, based on the revised assessment will be issued.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4719429152.D