Did an exemption from federal self-employment tax prevent Virginia from taxing income included in federal adjusted gross income after an IRS audit?

Subject

Virginia Code § 58.1-311 requires individuals to report a change or correction in federal taxable income within one year of the final determination.

Plain-English summary

The IRS increased a married couple's federal adjusted gross income for 2012 and 2013. Virginia matched the federal record and assessed additional state tax while the couple continued contesting the audit federally.

The couple argued that the husband's income was not subject to federal self-employment tax because he was not a U.S. citizen and worked for the Organization of American States. Virginia explained that self-employment tax is separate from income tax: income can remain in federal adjusted gross income even when it is not subject to self-employment tax.

Virginia therefore upheld the current assessments and would not look behind the IRS's determination. If the IRS later changed the audit result, the couple could file amended Virginia returns within one year of the later final federal determination.

What this means for you

• Federal self-employment-tax treatment does not determine Virginia income-tax treatment.
• Virginia generally starts with federal adjusted gross income.
• Report a final federal adjustment to Virginia within one year.
• A later IRS reduction can create a new one-year window for a corresponding Virginia amendment.

Citations and references

• Va. Code §§ 58.1-301, 58.1-322, 58.1-311, and 58.1-312 A 3.
• IRC §§ 1401 and 1402.
• Va. Code § 58.1-1823 A(ii); 23 VAC 10-20-180 B.
• P.D. 11-107.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-120

Original ruling text

June 29, 2017

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessment issued to * (the “Taxpayers”) for the taxable years ended December 31, 2012 through 2013. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayers filed Virginia individual income tax returns for the 2012 and 2013 taxable years. The Department received information from the Internal Revenue Service (IRS) that the Taxpayers' federal adjusted gross income was adjusted under audit. In response, the Department adjusted the Taxpayers' FAGI to match the federal record and issued an assessment for additional tax and interest. The Taxpayers filed an appeal, contending they were contesting the audit at the federal level.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, that terminology and references used in Title 58.1 of the Code of Virginia 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 federal adjusted gross income (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.

The Taxpayers assert that the income at issue was not subject to the tax on self-employment income because the husband was not a United States citizen during the taxable years at issue and worked for the Organization of American States. Generally, IRC § 1401 imposes a tax (commonly referred to as the self-employment tax) in addition to income tax on every individual's self-employment income as defined under IRC § 1402. Because this tax is imposed in addition to federal income tax, an individual's income that does not result from self-employment will be taxed as income even if it is not subject to the self-employment tax.

Virginia statutes do not add a tax to self-employment income. As such, the fact that income is not subject to self-employment tax would not have an impact as to whether the income was subject to Virginia income tax. As indicated above, income will be subject to Virginia tax if it is included in FAGI.

The Department received notification from the IRS that the Taxpayers' FAGI was adjusted under audit. Typically, where the IRS has audited the federal taxable income of a taxpayer, the Department does not look behind the IRS's final determination. See Public Document (P.D.) 11-107 (6/14/2011). Virginia Code § 58.1-311 requires individuals to report a change or correction in federal taxable income within one year of the final determination of such change or correction by filing an amended return with the Department. If the taxpayer fails to file an amended return, Va. Code § 58.1-312 A 3 permits the Department to assess the appropriate tax at any time. Because the determination of FAGI was made pursuant to a federal audit, the Department has no basis to grant relief.

Generally, Va. Code § 58.1-1823 allows a taxpayer to file an amended return within three years from the last day prescribed by law for the timely filing of the return. Virginia Code § 58.1-1823, however, also includes a number of exceptions to the general rule when specific circumstances are present. Under Va. Code § 58.1-1823 A (ii), a taxpayer may timely file an amended return within one year from the final determination of any change or correction in the liability of the taxpayer for any federal tax upon which the state tax is based, provided that the refund does not exceed the amount of the decrease in Virginia tax attributable to such federal change or correction.

Under Title 23 of the Virginia Administrative Code (VAC) 10-20-180 B, a final determination of a change in liability for the federal tax includes, with certain exceptions, the refund by the IRS of any federal income or estate tax. A final determination may also include a copy of an RAR, Form 870, 90-day letter, closing agreement, or court decision. Thus, under Title 23 VAC 10-20-180 B, a taxpayer may have more than one final determination for a given taxable year. Therefore, if the IRS adjusts its audit findings for the 2012 and 2013 taxable years, the Taxpayers will be permitted to file an amended return to correct their liability pursuant to Va. Code § 58.1-311 and Va. Code § 58.1-1823 A (ii).

However, the assessments are based on current IRS information issued for the 2012 and 2013 taxable years and are, thus, considered correct and remain due and payable. A revised bill with interest accrued to date, will be mailed shortly to the Taxpayer. No further interest will accrue provided the outstanding assessment is paid within 30 days from the date of the bill.

The Code of Virginia sections, regulation, 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 determination, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/858.D