Could Virginia residents claim an out-of-state credit merely because South Carolina tax was withheld when they appeared to owe no South Carolina tax?

Plain-English summary

Virginia residents claimed a credit for South Carolina withholding even though they did not file a South Carolina return and appeared to fall below its nonresident filing threshold.

Virginia denied the credit. Money withheld is not enough; the residents had to show actual liability for South Carolina income tax.

Liability and payment are both required

Va. Code § 58.1-332(A) allows a credit when qualifying out-of-state income is taxed by Virginia and the resident is liable for and pays the other state's income tax.

The couple's South Carolina income was below the applicable filing threshold. Based on South Carolina's progressive brackets, Virginia concluded they appeared to owe no South Carolina tax and could potentially obtain a full withholding refund.

Credit limitation

Even when a credit applies, it is limited to the lesser of actual tax paid to the other state or Virginia tax imposed on that income. Virginia uses a fraction comparing the other-state taxed income with Virginia taxable income.

What this means for you

• Withholding is a prepayment, not proof of final tax liability.
• File or otherwise document the other state's actual liability.
• Seek a refund from the other state when withholding exceeds tax due.
• Expect Virginia's credit limitation even when liability is proven.

Common questions

Q: Did the couple's choice not to file South Carolina establish the tax?

A: No. The available facts instead suggested no South Carolina liability.

Q: Could they claim the full amount withheld?

A: Not without proving liability, and any allowed credit would still be capped by Virginia law.

Citations and references

• Va. Code § 58.1-332(A) — other-state credit
• S.C. Code Ann. §§ 12-6-4910(1)(d), 12-6-510, 12-6-520 — threshold and rates
• Related Virginia ruling cited: P.D. 97-301

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-31

Original ruling text

April 17, 2019

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek a refund of individual income tax paid by * (the “Taxpayers”) for the taxable year ended December 31, 2017.

FACTS

The Taxpayers, a husband and wife, filed a Virginia resident individual income tax return for the 2017 taxable year, claiming a credit for income tax paid on income earned in South Carolina. Under audit, the Department disallowed the credit because the Taxpayers did not provide a South Carolina tax return. The Taxpayers paid the assessment and filed an appeal, contending they could claim the credit because income tax was withheld in South Carolina and they were not required to file a South Carolina return.

DETERMINATION

Virginia Code § 58.1-332 A allows Virginia residents who are liable for an income tax in another state to claim a credit on their Virginia return for income taxes paid to another state provided the income is either earned or business income or gain from the sale of a capital asset, derived from sources outside Virginia, and subject to Virginia’s income tax. 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.

Pursuant to S.C. Code Ann. § 12-6-4910(1)(d), nonresident taxpayers are not required to file a South Carolina income tax return if their South Carolina gross income is less than the personal exemption amount provided under IRC § 151(d). In this case, the Taxpayer’s South Carolina gross income in 2017 was less than the federal personal exemption amount for that year. Because they believed they were not required to file a South Carolina income tax return, the Taxpayers chose to claim a credit on their 2017 Virginia return for the South Carolina income tax withheld.

Like many states, South Carolina provides graduated and progressive tax brackets that are adjusted annually for inflation. See S.C. Code Ann. §§ 12-6-510 and 12-6-520. Based on these brackets, it appears the Taxpayers would not have been liable for South Carolina income tax and could have been eligible for a refund of their entire withholdings.

In order to claim the out-of-state credit, Virginia residents must be both liable for and pay the income tax due to the other state. See Virginia Code § 58.1-332 A. In this case, the Taxpayers did not appear to be liable for South Carolina income tax. Until they can show they were liable for South Carolina income tax, the Taxpayers could not claim the out-of-state credit for income tax withheld by South Carolina on their 2017 Virginia resident income tax return. As such, the Taxpayers’ request for a refund of income tax paid to Virginia for the 2017 taxable year cannot be granted.

The Code of Virginia sections 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

Related Documents

97-301