Could new Virginia residents claim Virginia's other-state credit for California tax on a 2010 installment payment from a business interest sold before they moved?

Plain-English summary

Virginia denied the residents' credit because California, not Virginia, was the state required to grant relief from double taxation. The taxpayers sold a California business interest on the installment method in 2007 while California residents, then moved to Virginia. They received a payment in 2010 as Virginia residents and paid California tax on it.

California sourced the gain to the taxpayers' residence when the intangible interest was sold, so it continued treating the installments as California-source income. Virginia taxed the 2010 payment because income from an intangible asset received by a Virginia resident was Virginia-source taxable income under the ruling's analysis.

Virginia's credit statute coordinated with the other state's credit rules. Virginia generally denied its resident credit when the other state allowed a substantially similar credit on the nonresident return. The Department found no California provision barring a nonresident credit for Virginia net income tax on this gain, and cited California authority supporting such a credit.

The taxpayers therefore had to seek the credit on their California nonresident return. Virginia upheld its 2010 assessment.

Common questions

Q: Why did both states tax the same installment payment?
A: California sourced it to the 2007 sale while the taxpayers lived there; Virginia taxed it because they were Virginia residents when they received it.

Q: Which state had to provide the credit?
A: California, because its law allowed a nonresident credit for qualifying tax paid to the state of residence.

Q: Would Virginia ever grant the credit instead?
A: The ruling said Virginia could do so when the reciprocal state limited or denied the corresponding nonresident credit, subject to Virginia's statutory limits.

Citations and references

• Va. Code § 58.1-332(A), (B).
• Cal. Rev. & Tax. Code §§ 17952(d) and 18002.
• Virginia Public Documents 11-48 (March 31, 2011) and 94-355 (November 23, 1994).

Subject

Taxpayers not be entitled to claim an out-of-state tax credit on Virginia return

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-156

Original ruling text

October 4, 2012

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 "Taxpayers") for the taxable year ended December 31, 2010. I apologize for the delay in responding to your letter.

FACTS

The Taxpayers were residents of California when they sold their ownership interest in a business located in California on the installment basis in 2007, after which they moved to Virginia and became domiciliary residents of Virginia. For the installment payment received in 2010 while residents of Virginia, the Taxpayers claimed a credit for taxes paid to California on their 2010 Virginia income tax return. The Department disallowed the credit and issued an assessment. The Taxpayers filed an appeal, contending California imposed tax on the installment payment received in 2010, and the credit should be allowable by Virginia.

DETERMINATION

Virginia Code § 58.1-332 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. Further, this code section states:

The credit . . . shall not be granted to a resident individual when the laws of another state, under which the income in question is subject to tax assessment, provide a credit to such resident individual substantially similar to that granted by subsection B of this section.

Under Va. Code § 58.1-332 B, a nonresident is permitted to claim a credit from tax on income from Virginia sources when their home state provides a substantially similar credit to Virginia residents or imposes a tax upon the income derived from Virginia sources that is exempt from taxation by Virginia. Because it is dependent on another state granting a similar or reciprocal credit, it may be limited by the credit permitted by the other state.

As a general rule, Virginia law does not allow a resident to claim a credit on his Virginia return for taxes paid to California because California law allows a Virginia resident to claim the credit on his California nonresident return. Similarly, a California resident would claim the credit for tax paid to California on his Virginia nonresident return.

In this case, the Taxpayers were contacted by California about the installment sale income. Under Cal. Rev. & Tax. Code § 17952(d), the source of gains on the sale of intangible personal property is determined at the time of the sale. Because the Taxpayers were residents of California at the time of the sale, California considers the gain recognized on the installments to be California source income even though the Taxpayers received the payment after they moved to Virginia.

In Public Document (P.D.) 11-48 (3/31/2011), the Department ruled that, to the extent installment payments result from the gain or sale of an intangible asset not employed in a trade or business carried out in Virginia, such payments would not be subject to Virginia income tax when received by a nonresident of Virginia. Conversely, such income is considered to be Virginia source income taxable when received by a resident of Virginia.

The issue, therefore, becomes which state should grant the credit for taxes paid to another state. The Department previously addressed an issue in which California will not grant the credit in P.D. 94-355 (11/23/1994). In that ruling, the Department determined that when a reciprocity state does not allow credit on a nonresident return for individual income tax paid to another state, the individual may claim the credit on the Virginia resident income tax return. Thus, when a state that practices reciprocity with Virginia for purposes of claiming the individual tax credit on their nonresident individual income places a limitation on such reciprocity, the out-of-state credit would be allowed, to the extent permitted under Va. Code § 58.1-332 A, on an individual's Virginia income tax return.

In this case, however, the Department cannot find any provision in Cal. Rev. & Tax. Code § 18002 that would prohibit nonresidents from claiming the credit for net income taxes imposed by and paid to the state of residence on income resulting from a sale of intangible personal property. Further, the California Second District Court of Appeal, Division 5 (the "Court") has ruled in a case involving gains on the sales of business interests in California in Gray et al. v. Franchise Tax Board , 235 CaI.App.3d 36, 286 Cal. Rptr. 453 (1991). In ruling that Connecticut's tax on net gains from the sale of capital assets was a net income tax and California must allow an out-of-state credit to the taxpayers, the Court inferred that income from intangible assets received by nonresident taxpayers qualifies for the credit under Cal. Rev. & Tax. Code § 18002.

Because a credit for income tax paid to Virginia would be allowable on the California nonresident individual income tax return, the Taxpayers would not be entitled to claim an out-of-state tax credit on their 2010 Virginia return. As such, the Department was correct in denying the credit. Accordingly, the assessment for the 2010 taxable year is upheld.

The Taxpayers will receive an updated bill with interest accrued to date. The outstanding balance should be paid within 30 days of the bill date to avoid the accrual of additional interest.

The Code of Virginia sections and public documents cited 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 Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4969669408.E