Could Virginia residents subtract foreign salary, foreign investment gains, and the 2011 portion of a 2010 Roth IRA conversion from federal adjusted gross income?

Subject

Roth IRA; Capital Gains from Foreign Investments; Taxable Income

Plain-English summary

Virginia upheld the assessment because none of the claimed foreign-income or Roth-conversion amounts had an authorized Virginia subtraction. The couple became Virginia residents in late 2010 and included the disputed amounts in their 2011 federal adjusted gross income.

Virginia taxed salary, incentive payments, employer-paid foreign tax, and a bonus received in 2011 even though the taxpayers attributed them to work performed abroad in 2010. Virginia begins with federal adjusted gross income and had no listed modification for those items.

The foreign investment gains were also taxable. Virginia's former foreign-source-income subtraction for individuals had been repealed for taxable years beginning on or after January 1, 2003. Finally, federal law spread the taxable amount of a 2010 traditional-to-Roth IRA conversion over two years; the 2011 share properly entered federal adjusted gross income, and Virginia allowed no subtraction merely because the traditional IRA contributions were made while living elsewhere.

What this means for you

• Virginia generally taxes amounts included in a resident's federal adjusted gross income unless a specific state modification applies.
• Income received after becoming a Virginia resident can be taxable even when related to earlier foreign work.
• Foreign investment gains do not receive the repealed individual foreign-source subtraction discussed in this ruling.
• A Roth-conversion inclusion does not become subtractable solely because the original IRA contributions arose outside Virginia.

Common questions

Q: Did earning the compensation abroad in 2010 make it exempt in 2011?

A: No. It was received and included in federal adjusted gross income while the taxpayers were Virginia residents.

Q: Were foreign capital gains subtractable?

A: No. The former subtraction had been repealed for years beginning on or after January 1, 2003.

Q: Could they subtract the Roth conversion's 2011 share?

A: No. It was properly included in federal adjusted gross income under the federal ratable-inclusion rule.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322.
• IRC § 408A(d)(3)(A)(iii).
• New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937).
• P.D. 03-54, P.D. 07-1, P.D. 08-103, P.D. 09-50, P.D. 98-44, and P.D. 05-124.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-52

Original ruling text

April 3, 2015

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the Virginia individual income tax assessment issued to * (the "Taxpayers") for the taxable year ended December 31, 2011.

FACTS

The Taxpayers, a husband and wife, moved to Virginia from * (Country A) in late 2010 when the husband was transferred by his employer. The Taxpayers filed their 2011 Virginia resident individual income tax return claiming several subtractions and deductions of income. The Department audited the 2011 return and disallowed certain subtractions for income the Taxpayer's attributed to Country A. The Department also disallowed a subtraction of a distribution of income resulting from the conversion of a traditional individual retirement account (IRA) into a Roth IRA. The Taxpayers paid the assessment in full and filed an appeal, contending that the subtractions and deductions disallowed by the Department were for income attributable to the 2010 taxable year.

DETERMINATION

Taxability of Income

The Taxpayers subtracted a portion of the husband's base salary, incentive maintenance payments, foreign tax paid by his employer, and bonus derived from the husband's work performed in Country A during the 2010 taxable year.

It has been well established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In New York ex rel. Cohn v. Graves , 300 U.S. 308, 57 S.Ct. 466 (1937), the United States Supreme Court explained "[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized." Thus, any resident who has Virginia taxable income as determined under Taxpayer was not a resident of Virginia for the 2011 taxable year and was not required to file a Virginia Resident Income irginia's statutes is subject to Virginia income tax.

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the 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 federal adjusted gross income (FAGI). Income properly 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. A resident of Virginia includes any natural person domiciled in Virginia at any time during a taxable year or who, for an aggregate of more than 183 days of the taxable year, maintained his place of abode within Virginia.

Accordingly, any income that the Taxpayers received while they were Virginia residents in 2011 was subject to Virginia income tax even if attributable to income earned in Country A during the 2010 taxable year unless it was specifically exempt as a Virginia modification pursuant to Va. Code § 58.1-322. Because Va. Code § 58.1-322 does not provide modifications for base salary, incentive maintenance payments, and foreign tax paid by an employer, the subtractions and deductions from the Taxpayers' 2011 FAGI that they attributed to Country A were properly disallowed by the Department.

Capital Gains from Foreign Investments

In addition, the Taxpayers subtracted a portion of their capital gains from investments in foreign entities because they came from funds which did not "have a Virginia participation." The Department disallowed the capital gains subtracted by the Taxpayers for the 2011 year.

At one time, Va. Code § 58.1-322 did provide a subtraction from FAGI for certain foreign source income. However, the General Assembly specifically repealed the subtraction effective for taxable years beginning on and after January 1, 2003. Because the foreign gain was included in the Taxpayers' FAGI and the Code of Virginia does not permit a subtraction for such income, the Department was correct in disallowing the subtraction on the 2008 income tax return. Virginia's policy has been consistently articulated in P.D. 03-54 (5/3/2003), P.D. 07-1 (2/22/2007), P.D.08-103 (6/18/2008), and P.D. 09-50 (4/27/2009).

Roth IRA

The Taxpayers claimed a subtraction for a 2010 distribution that was ratably included in the Taxpayers' FAGI when converting a traditional IRA into a Roth IRA. The Taxpayers contend they should be able to claim a subtraction for the 2011 distribution.

Beginning in 2010, IRC § 408 A(d)(3)(A)(iii) permits a ratable portion of a distribution from a traditional IRA and rolled over to a Roth IRA to be included in FAGI over the two taxable year period. In accordance with this provision, the Taxpayers appropriately included the distribution in FAGI reported on the Virginia return. However, they erroneously claimed a subtraction for the amount of the distribution.

The Department has issued rulings to address similar provisions in the past. See P.D. 98-44 (3/9/1998) and P.D. 05-124 (7/25/2005). In fact, P.D. 05-124 specifically states that no subtraction is permitted for distributions when converting a traditional IRA to a Roth IRA where the contributions were made to the traditional IRA when the taxpayer resided in another state.

CONCLUSION

Individual income taxpayers are limited to modifications to FAGI enumerated in Va. Code § 58.1-322. As indicated above, this section does not provide subtractions or deductions for the types of income claimed by the Taxpayers on their 2011 income tax return. Accordingly, the Department correctly disallowed the subtractions and deductions. The assessment, therefore, is upheld and your request for a refund must be denied.

The Code of Virginia sections and public documents 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/1-5888720829.B