Could taxpayers subtract gains from Virginia bonds when unrelated capital losses had already offset all of those gains in federal adjusted gross income?

Subject

Bond gain subtraction denied after capital-loss offset

Plain-English summary

Virginia denied the subtraction for gains from Virginia bonds because current and carried-over capital losses had already offset all of those gains in federal adjusted gross income. Nothing remained in FAGI to subtract on the Virginia return.

The Virginia subtraction covered income from Commonwealth and political-subdivision obligations only to the extent that income was included in FAGI. Federal rules did not require the bond gains to be matched only against losses from the same class of Virginia obligations; losses from sales of other property could offset them.

Because the taxpayers' other capital losses eliminated all bond gains before FAGI was calculated, the Department upheld the assessment.

What this means for you

• A Virginia subtraction cannot remove income that federal netting has already eliminated from FAGI.
• Capital-loss carryovers can reduce or erase the state subtraction available for otherwise qualifying bond gains.
• The source of the offsetting losses did not need to match the Virginia obligations.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322 C 2; IRC §§ 62, 1211(b), and 1212(b).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-188

Original ruling text

December 11, 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 "Taxpayers") for the taxable year ended December 31, 2011.

FACTS

The Taxpayers claimed a subtraction for income from the sale of Virginia bonds on their 2011 Virginia individual income tax return. Under review, the Department denied the subtraction and issued an assessment for additional tax on the basis that the income had not been included in the Taxpayers' federal adjusted gross income (FAGI) because it had been offset by losses from the sale of other property. The Taxpayers appeal the assessment, contending that the subtraction should be allowed because the losses were not attributable to the sale of Virginia obligations.

DETERMINATION

Virginia Code § 58.1-301 provides that the terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. For individual income tax purposes, Virginia conforms to federal law in that it starts the computation of Virginia taxable income with FAGI. Income included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Va. Code § 58.1-322.

Pursuant to Va. Code § 58.1-322 C 2, taxpayers are allowed to subtract from FAGI income from obligations, or the sale or exchange of obligations of the Commonwealth or any of its political subdivisions or instrumentalities to the extent the income is included in FAGI.

IRC § 62 defines "adjusted gross income" as gross income minus certain deductions, including deductions allowed for losses from the sale or exchange of property. See IRC § 62(a)(3). Such losses, however, are generally allowed only to the extent the taxpayer also had gains from other sales or exchanges of property. See IRC § 1211(b). In addition, net losses may be carried over to the succeeding taxable year pursuant to IRC § 1212(b).

In this case, the Taxpayers had income in the form of capital gains from the sale of Virginia bonds and subtracted the gains from FAGI pursuant to Va. Code § 58.1-322 C 2 in computing their Virginia taxable income. The Taxpayers, however, had incurred capital losses from the sale of other property, including losses carried over from the prior taxable year, which had entirely offset the gains in arriving at the Taxpayers' FAGI.

The Taxpayers contend that, pursuant to Public Document (P.D.) 97-259 (6/11/1997), the subtraction under Va. Code § 58.1-322 C 2 may only be reduced by losses incurred on the sale or exchange of other obligations of the Commonwealth. The Taxpayers state that they incurred no such losses either for the taxable year at issue or as a part of the losses that were carried over from the prior taxable year.

P.D. 97-259 involved the foreign source income subtraction under Va. Code § 58.1-322 C 7 (since repealed). In that case, the Department held that the foreign source income subtraction was only allowed to the extent that such income remained after deducting capital losses, expenses and other deductions attributable to foreign sources pursuant to IRC § 862(b).

The Taxpayers assert that because P.D. 97-259 required the foreign source income subtraction to be reduced by expenses, losses or other deductions attributable to foreign sources, then the subtraction in this case may only be reduced by losses attributable to other obligations of the Commonwealth.

In this case, however, the IRC does not require gains from the sale or disposition of such obligations to be matched to losses attributable to that specific class of property. In determining a taxpayer's FAGI, IRC § 62(a)(3) provides a deduction for losses from the sale or exchange of any property. In this case, the losses incurred by the Taxpayers offset all of their gains, including the gains from the sale of the Virginia bonds. As such, none of the gains from the sale of the bonds remained to be subtracted on the Virginia return.

Accordingly, the Department's assessment is upheld. An updated bill, with accrued interest to date, will be mailed to the Taxpayers shortly. No further interest will accrue provided the outstanding balance is paid within 30 days from the date indicated on the revised bill.

The Code of Virginia sections and public document 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 ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5745473424.M