Can a Virginia resident claim a state subtraction or credit for Mexican tax on Mexican rental income that was not fully usable as a federal foreign-tax credit?

Plain-English summary

A Virginia resident earned rental income in Mexico and paid Mexican tax. She claimed a federal foreign-tax credit but could not use the full amount. After conceding that her original Virginia subtraction was improper, she argued that Virginia's federal conformity or the U.S.-Mexico income-tax treaty should give her a state subtraction, deduction, or credit for the remaining Mexican tax.

The Department said no: Virginia law provided no credit for this rental income, and the treaty did not apply to Virginia state tax.

Federal conformity does not import the federal credit

Virginia starts an individual's tax calculation with federal adjusted gross income (Va. Code § 58.1-301). That means the Mexican rental income, which was included in federal adjusted gross income, also entered Virginia taxable income unless a specific Virginia modification applied.

The taxpayer agreed that neither of Virginia's potentially relevant credits covered her facts:

• Va. Code § 58.1-332 — credit for qualifying tax paid to another state; and
• Va. Code § 58.1-332.1 — foreign-country tax credit for qualifying retirement income.

IRC §§ 901 and following allowed her federal foreign-tax credit, but Virginia conformity does not automatically create an equivalent state credit. Va. Code § 58.1-332.2 defines “income tax” for the Virginia credit statutes; it does not independently authorize a credit. No Virginia subtraction, deduction, or credit applied to Mexican tax on this rental income.

Why the U.S.-Mexico treaty did not control Virginia

Article 2 of the U.S.-Mexico Income Tax Convention identifies the covered U.S. taxes as federal income taxes imposed by the Internal Revenue Code. The Department concluded that the convention affects specified federal and Mexican national taxes, not taxes imposed by Virginia or other state and local governments.

The treaty therefore did not exempt the rental income from Virginia tax or require Virginia to grant a credit.

What this means for you

• A federal foreign-tax credit does not automatically produce a Virginia credit. Federal conformity primarily supplies the income starting point and shared terminology.
• Virginia's foreign-country credit is limited. The taxpayer conceded that the retirement-income credit did not cover Mexican rental income.
• An unused federal credit is not a Virginia subtraction. A Virginia statute must specifically authorize the state benefit.
• Read treaty coverage provisions carefully. The treaty here covered identified national taxes, not Virginia state income tax.

Common questions

Q: Can I put the unused portion of my federal foreign-tax credit on my Virginia return?

A: Not without a Virginia statute authorizing the credit or subtraction. The unused Mexican-tax amount here was not allowed.

Q: Does Virginia offer any foreign-country tax credit?

A: Va. Code § 58.1-332.1 provides one for qualifying retirement income, but the taxpayer agreed it did not apply to this rental income.

Q: Did the U.S.-Mexico treaty prevent Virginia from taxing the rental income?

A: No. The ruling found that the treaty applied to specified federal and Mexican national taxes, leaving Virginia state tax unaffected.

Citations and references

• Va. Code § 58.1-301 — Virginia federal conformity
• Va. Code §§ 58.1-322.01 through 58.1-322.04 — Virginia modifications
• Va. Code § 58.1-332 — credit for tax paid to another state
• Va. Code § 58.1-332.1 — foreign-country tax credit for retirement income
• Va. Code § 58.1-332.2 — definition of income tax
• IRC §§ 901 et seq. — federal foreign-tax credit
• U.S.-Mexico Income Tax Convention, Article 2 — covered taxes
• Related Virginia rulings cited: P.D. 96-228, P.D. 07-39, P.D. 13-232, P.D. 18-75

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-90

Original ruling text

August 15, 2019

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 “Taxpayer”) for the taxable year ended December 31, 2015.

FACTS

The Taxpayer filed a 2015 Virginia resident individual income tax return, claiming an unspecified subtraction. The Department requested additional information to determine if the Taxpayer qualified for a subtraction. When an adequate response was not received, the Department disallowed the subtraction and issued an assessment for the 2015 taxable year. The Taxpayer conceded the Department’s disallowance of the subtraction and paid the assessment. The Taxpayer subsequently filed an appeal, contending she was entitled to a foreign income tax credit. The Taxpayer also asserts the income was not subject to Virginia income taxation pursuant to the United States – Mexico Income Tax Convention (the “Convention”).

DETERMINATION

Credit for Tax Paid to Another State

Virginia Code § 58.1-301 provides, with certain exceptions, 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. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . 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 eligible for a Virginia modification pursuant to Virginia Code §§ 58.1-322.01 through 58.1-322.04.

The Taxpayer agrees that neither the out-of-state tax credit in Virginia Code § 58.1-332, nor the credit for taxes paid to a foreign country on retirement income in Virginia Code § 58.1-332.1 apply in this case. The Taxpayer asserts that since Virginia individual income taxation “conforms” to federal law, then Virginia is obligated to honor the elimination of double taxation provisions of the Convention by allowing a subtraction, deduction, or credit on the Virginia return for those taxes paid to Mexico on rental income earned in Mexico.

IRC §§ 901 et seq. allow taxpayers to claim a credit against their federal tax liability for taxes paid to a foreign country in certain circumstances. Pursuant to those IRC sections, the Taxpayer claimed a credit on her 2015 federal income tax return for rental income earned in Mexico. The Taxpayer contends that she should be entitled to claim the remaining amount as a Virginia foreign tax credit because she could not claim the full amount of the foreign tax as a credit on her federal return.

By reason of their character as legislative grants, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell’s Motor Freight, Inc. et al. v. Virginia Dep’t of Taxation , Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).

Virginia Code § 58.1-332.2 provides a definition of the term “income tax” as used in Virginia Code §§ 58.1-332 and 58.1-332.1. As a definitional section, it does not authorize a taxpayer to claim a credit. Because the rental income the Taxpayer received was properly included in FAGI, it is also included in Virginia taxable income unless specifically exempted by Virginia Code §§ 58.1-322.01 through 58.1-322.04. As noted above, however, Virginia law does not allow a subtraction, deduction, or credit for foreign taxes paid on this type of income.

Convention

Article 2 of the Convention states in pertinent part, “The existing taxes to which this Convention shall apply are … in the United States, the Federal income taxes imposed by the Internal Revenue Code…” Pursuant to this article, the Convention applies only to certain taxes imposed at the federal level by the United States and the Mexican national governments. Taxes imposed by state and local governments, including Virginia, are unaffected by the Convention. See Public Document (P.D.) 96-228 (9/9/1996), P.D. 07-39 (4/20/2007), P.D. 13-232 (12/18/2013), and P.D. 18-75 (5/2/2018).

CONCLUSION

After carefully considering the information provided, the Department properly disallowed the Taxpayer’s subtraction for the 2015 taxable year. The Taxpayer was also unable to show that she was entitled to an income tax credit or that her income was not taxable pursuant to the Convention. Accordingly, the assessment is upheld. Because the assessment has been paid in full, no further action is required.

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/1971C

Related Documents

96-228

07-39

13-232

18-75