Could Virginia's other-state tax credit use a pass-through entity's full distributive income when the other state taxed a smaller amount?

Subject

Virginia law does not necessarily allow a taxpayer to claim a credit for the total amount of tax paid to another state.

Plain-English summary

A married couple claimed Virginia's credit for income tax paid to another state. In computing the limitation, they included the husband's entire distributive share of pass-through entity income as income taxed by that state.

The other state, however, calculated its tax after reducing that distributive share by a net federal-conformity modification. Virginia therefore used only the smaller amount that was actually subject to the other state's tax.

The Department explained that Virginia's credit is limited to the lesser of the tax actually paid to the other state or the Virginia tax imposed on the qualifying income earned or derived there. It upheld the adjustment and assessment; because the couple had already paid, no further action was required.

Citations and references

• Va. Code § 58.1-332 A.
• P.D. 97-301.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 16-158

Original ruling text

August 3, 2016

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 clients, * (the “Taxpayers”), for the taxable year ended December 31, 2012.

FACTS

The Taxpayers, a husband and a wife, filed a joint Virginia resident income tax return for the 2012 taxable year and claimed a credit for income tax paid to * (State A). The amount of State A taxable income the Taxpayers reported for purposes of computing the credit limitation included the husband's entire distributive share of pass-through entity (PTE) income. Under review, the Department reduced the amount of State A taxable income by the amount of an Internal Revenue Code (IRC) conformity modification reported by the PTE. The adjustment reduced the credit, and an assessment was issued. The Taxpayers appealed, contending they correctly reported the amount of taxable income on which State A tax was imposed.

DETERMINATION

Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state provided the income is either earned or business income. Virginia law does not necessarily allow a taxpayer to claim a credit for the total amount of tax paid to another state. Rather, the credit is limited to the lesser of the amount of tax actually paid to the other state or the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state. See Public Document (P.D.) 97-301 (7/7/1997). The limitation is computed by multiplying the individual's Virginia tax liability by a fraction, the numerator of which is the income upon which the other state's tax is imposed, and the denominator of which is Virginia taxable income.

The Taxpayers contend that the amount of income upon which State A tax was imposed included the husband's distributive share of income from the PTE, including the net IRC conformity modification. Although State A, like Virginia, generally “conforms” to federal law in that it starts the computation of State A taxable income with federal adjusted gross income (FAGI), it does not conform to the IRC in all respects. Therefore, State A requires taxpayers to make adjustments to their State A taxable income when such circumstances apply. In this case, the documentation provided indicates that the State A tax was computed only on the amount of the distributive share of PTE income reduced by the net IRC conformity modification. For purposes of computing the credit limitation under Va. Code § 58.1-332 A, taxpayers were limited to using only the amount of income that was actually subject to tax in the other state. As such, the Department's adjustment is correct.

Accordingly, the assessment is upheld. The Department's records indicate that the Taxpayers have paid the assessment. Therefore, no further action is required.

The Code of Virginia section and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rulings and Decisions section of the Department's website. 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/1-6271682911.M