Could a Virginia part-year resident claim a credit when a neighboring state taxed all of her wages, including wages also taxed during her Virginia-resident period?

Subject

Part-year resident received credit for wages taxed twice

Plain-English summary

Virginia allowed the credit because the neighboring state taxed the taxpayer's entire wages, including earned income that Virginia also taxed during her Virginia-resident period. The assessment was abated.

The Department initially believed the other state had taxed only the portion attributable to the taxpayer's residence there, which would not support a Virginia credit for her separate Virginia-resident period. A closer review showed that the other state's computation began with federal taxable income and applied an apportionment ratio that excluded only a small amount of Virginia interest. Her full wages were therefore taxed by the other state.

The similarity between the other state's taxable-income figure and the income assigned to the non-Virginia period was only coincidental. Because the same earned income was taxed by both states, the statutory credit served its double-tax-relief purpose.

What this means for you

• Compare the actual other-state tax computation, not just headline income figures.
• A part-year resident cannot claim a credit for tax paid to the prior residence state on income belonging only to that prior-resident period.
• The credit can apply when the other state taxes earned income that Virginia also taxes during the Virginia-resident period.

Citations and references

• Va. Code §§ 58.1-303 and 58.1-332 A; 23 VAC 10-110-221.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-181

Original ruling text

November 21, 2014

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, 2010.

FACTS

The Taxpayer filed a Virginia Part-Year Resident Income Tax Return for the 2010 taxable year and attributed a portion of her income to her period of residence outside Virginia. The Taxpayer also claimed a credit for income tax paid to * (State A). Under review, the Department determined that the Taxpayer had not paid taxes to State A on the portion of her income that she attributed to her period of residence in Virginia. The Department, therefore, denied the credit and issued an assessment for taxes due. The Taxpayer filed an appeal, contending that the credit should have been allowed because she paid taxes to State A on the same income that was subject to tax in Virginia.

DETERMINATION

Virginia Code § 58.1-303 provides that a person who becomes a resident of Virginia is subject to taxation during the period in which he or she is a Virginia resident and is taxed as a resident only for the portion of the year that he or she resides in Virginia.

Virginia Code § 58.1-332 A allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or any gain from the sale of a capital asset. The intent of the credit is to grant Virginia residents relief in situations when they are taxed by both Virginia and another state on these types of income.

As a general rule, the credit for income tax paid to another state by a Virginia resident is limited to the lesser of: (1) the amount of tax actually paid to the other state; or (2) the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state. In the case of a Virginia resident who pays income tax to a state like State A that borders Virginia, a special rule can apply.

If certain criteria are met, the limitation that restricts the credit to the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state is disregarded. The special rule will apply if the income subject to tax in a single state contiguous to Virginia is less than Virginia taxable income and all of the income from sources outside Virginia is earned income or business income reported on federal form Schedule C from that single contiguous state. In such instances, the Virginia resident will be entitled to a credit equal to the lesser of: (1) the amount of income tax actually paid to the contiguous state; or (2) 100% of their Virginia income tax liability. See Va. Code § 58.1-332(A).

Title 23 of the Virginia Administrative Code (VAC) 10-110-221 specifically defines the term earned income as "wages, salaries, or professional fees and other amounts received as compensation for professional services actually rendered . . . ."

Notwithstanding the provisions of Va. Code § 58.1-332, Va. Code § 58.1-303 prohibits part-year residents from claiming any credit against their Virginia tax liability for tax paid to any other state or jurisdiction of residence or domicile for that portion of the taxable year during which they were a resident of such other state or jurisdiction.

In this case, the Department determined that the Taxpayer had reported to Virginia and State A the respective portions of her wage income that were attributable to her periods of residency in each state. Thus, the Department concluded that the credit for income tax paid to State A should be disallowed because the Taxpayer had not paid taxes to State A on the portion of income the Taxpayer attributed to her period of Virginia residency.

The Taxpayer, however, contends that she paid taxes to State A on the entire amount of her wages because it was State A source income that was subject to tax by State A even during her period of Virginia residency. The Taxpayer asserts that it is a mere coincidence that the amount of income which she attributed to her period of residency outside Virginia was very close to the amount of State A taxable income computed on the State A return.

Unlike Virginia which begins the computation of tax with federal adjusted gross income (FAGI), the starting point for the computation of State A's income tax is federal taxable income (FTI) which already accounts for any deductions and exemptions to which a taxpayer is entitled. In this case, the Taxpayer computed her State A taxable income by adding back to FTI the amount of additions required by State A law. To that figure, the Taxpayer applied an apportionment ratio that excluded only a small amount of interest income the Taxpayer had attributed to Virginia. The Taxpayer, therefore, paid taxes to State A on her entire wage income.

As the Taxpayer indicates, it was merely a coincidence that the amount of State A taxable income reported on her State A return was close to the amount of income the Taxpayer attributed to her period of residence outside Virginia on her Virginia return. Unlike the State A return, that amount on the Virginia return was computed before accounting for the Taxpayer's itemized deductions and exemptions.

Because the Taxpayer paid taxes to State A on earned income that was also subject to tax in Virginia, the credit for taxes paid to State A should have been allowed. Accordingly, the assessment for the 2010 taxable year will be abated.

The Code of Virginia sections and regulation cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5758036226.M