Could a Virginia resident working abroad for a U.S. government contractor use the federal foreign earned income exclusion and fall below Virginia's filing threshold?

Subject

Foreign earned income exclusion as provided by IRC § 911(a)(1).

Plain-English summary

Virginia assessed a married couple as 2012 nonfilers after receiving federal information. The husband had worked in another country for the entire year as an employee of a United States-based government contractor.

Virginia accepted the couple's federal foreign earned income exclusion under IRC § 911(a)(1). The rule generally did not cover pay from the United States government, including certain armed-forces, embassy, and loaned federal employees, but the husband was employed by a private government contractor.

After the exclusion, the couple's Virginia adjusted gross income was below the $23,900 filing threshold for a married couple in 2012. Virginia therefore abated the assessment. The couple still had to report any later federal change to the exclusion within one year.

What this means for you

• Virginia generally follows a properly claimed federal foreign earned income exclusion.
• Employment by a government contractor is not automatically the same as employment by the United States.
• Resident filing obligations depend on both federal filing status and Virginia adjusted gross income.
• A later IRS change to the exclusion must be reported to Virginia within one year.

Citations and references

• Va. Code §§ 58.1-301, 58.1-322, and 58.1-219.
• IRC § 911(a)(1).
• Va. Code §§ 58.1-341, 58.1-321 A 2, 58.1-311, and 58.1-312 A 3.
• P.D. 12-29.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-131

Original ruling text

July 19, 2017

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, 2012. I apologize for the delay in responding to your appeal.

FACTS

The Department received information from the Internal Revenue Service (IRS) indicating that the Taxpayers, a husband and a wife, may have been required to file a Virginia individual income tax return for the 2012 taxable year. The Department requested information to verify whether the Taxpayers were subject to Virginia income tax. When a response was not received, the Department issued an assessment based on federal data. The Taxpayers filed an appeal, contending they did not reside in Virginia during the 2012 taxable year and they earned all income in * (Country A) and their Virginia taxable income was below the filing threshold.

DETERMIATION

Foreign Income Exclusion

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 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 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.

As a general rule, the Department relies on the accuracy of information and computations reflected on the federal income tax return when reviewing Virginia individual income tax returns. If the information provided on the federal return appears reasonable, there is generally no reason to look behind those computations. However, the Department retains the authority to adjust the FAGI where there is clear evidence that the amounts reported on the federal or Virginia income tax return are not consistent with the IRC. See Va. Code § 58.1-219.

The Taxpayers, residents of Virginia, claim they lived and worked in * in 2012 and claimed a foreign income exclusion on their federal income tax return. IRC § 911 allows qualified individuals to exclude a portion of their income attributable to their presence in a foreign country. Generally, this exclusion does not apply to individuals who are paid by the United States, including members of the armed forces, embassies, and federal employees loaned to foreign governments, even if the foreign government reimburses the United States for his salary. See Public Document (P.D.) 12-29 (3/21/2012).

The Taxpayers have provided documentation showing the husband was employed by a government contractor based in the United States. He was assigned to a position in Country A in October 2011 and worked there for the entire 2012 taxable year. As such, the Taxpayers were allowed to take advantage of the foreign earned income exclusion as provided by IRC § 911(a)(1).

Filing Threshold

Virginia Code § 58.1-341 provides that a Virginia resident who is required to file a federal income tax return is also required to file a Virginia income tax return, unless the resident is exempt from filing under Va. Code § 58.1-321. Additionally, even if a resident is not required to file a federal return but has Virginia adjusted gross income that exceeds the filing threshold, the resident is required to file a Virginia individual income tax return.

Under Va. Code § 58.1-321 A 2, a return is not required to be filed if a married couple's combined Virginia adjusted gross income (VAGI) for a taxable year is less than $23,900. After reducing the Taxpayers' income by the foreign income exclusion, their VAGI was less than the threshold required for filing a Virginia income tax return. According, the assessment will be abated.

While the Department has ruled that the husband's compensation was eligible for the foreign income exclusion, Va. Code § 58.1-311 would require the Taxpayers to report a change or correction in federal taxable income, including changes to the foreign income exclusion, within one year of the final determination of such change or correction by filing an amended return with the Department. If the Taxpayers fail to file an amended return, Va. Code § 58.1-312 A 3 permits the Department to assess the appropriate tax at any time.

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 determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/662.D