Can a Virginia resident claim a credit for income tax paid to California if the spouse is also an actual resident of California?

Subject

Credit : Tax Paid to Another State - California Dual Resident

Plain-English summary

A husband and wife filed a 2019 Virginia resident income tax return and claimed a credit for income tax the husband paid to California. The Department of Taxation denied the credit on review, and the Taxpayers appealed, arguing the husband was an actual resident of California (not just someone who happened to earn California-source income).

Normally, Virginia will not let a Virginia resident claim a credit for tax paid to California, because California's own law lets a Virginia resident claim the equivalent credit on a California nonresident return instead -- Va. Code § 58.1-332 A blocks the Virginia credit whenever the other state offers a "substantially similar" credit back. But the Department explained that dual residency changes the analysis: if the husband was truly an actual resident of California while also being a domiciliary resident of Virginia, then California law would not let him claim a credit on a California nonresident return (since he wouldn't be filing as a nonresident there), and Virginia law would not block the credit either. In that scenario, the credit belongs on the Virginia return, subject to Virginia's usual limitation (the credit cannot exceed the lesser of the tax actually paid to California or the Virginia tax actually imposed on that same income).

The catch: the Department had denied the credit without ever addressing whether the husband was actually a California resident. Because that threshold question was never evaluated, the Tax Commissioner sent the case back to the unit that made the original adjustment, directing it to request supporting documentation (such as a California resident income tax return), review it, and issue a new written explanation of whatever it decides -- with a fresh 90-day appeal window running from that new decision.

What this means for you

Couples or individuals with residency ties to both Virginia and California

If one spouse is domiciled in Virginia but is also an actual (not just nonresident) resident of California, don't assume the standard "no credit for CA tax" rule applies to you. That rule exists because California normally lets Virginia residents claim the credit on their California nonresident return -- but a dual resident isn't filing as a nonresident in California, so the reciprocal credit isn't available there. In that situation, Virginia may need to be the state that grants the credit instead.

Taxpayers appealing a credit denial

This ruling shows the Department can send a case back for further fact-finding when the original denial notice didn't explain its reasoning and didn't address a residency argument the taxpayer raised. If you're appealing a similar denial, be ready to substantiate actual residency in the other state (for example, with a copy of your resident return filed there) once asked.

Accountants and tax professionals

Remember that Virginia's credit under Va. Code § 58.1-332 A is capped at the lesser of the tax actually paid to the other state or the Virginia tax actually imposed on that income, computed as a fraction of Virginia tax liability. Even where a dual-resident credit is allowed in principle, this limitation still applies, so don't assume a full dollar-for-dollar offset of the California tax paid.

Common questions

Q: Why did Virginia deny the credit for tax paid to California in the first place?
A: As a general rule, Virginia does not allow its residents a credit for tax paid to California because California law lets a Virginia resident claim the equivalent credit on a California nonresident return instead. Va. Code § 58.1-332 A blocks Virginia's credit whenever the other state grants a "substantially similar" credit back to Virginia residents.

Q: Why might this couple still get the credit?
A: The Taxpayers argued the husband was an actual resident of California, not merely someone who worked there. If that's true, California would not let him claim a credit on a California nonresident return (because he isn't a nonresident there), and Virginia law would not bar the credit either -- so it would be allowed on the Virginia return, per the Department's prior ruling in P.D. 94-355 and consistent with P.D. 20-46.

Q: Did the Department actually decide the husband was a California resident?
A: No. The Department found that the original denial notice never addressed that question, so it returned the case to the unit that made the adjustment for re-evaluation, including a request for documentation such as a California resident income tax return.

Q: How much of the California tax can be credited, even if residency is confirmed?
A: The credit is limited to the lesser of the tax actually paid to California or the Virginia income tax actually imposed on the income earned in California, computed by multiplying Virginia tax liability by a fraction (California-taxed income over Virginia taxable income).

Q: What happens next for the Taxpayers?
A: The reviewing unit must evaluate the residency claim, consider any documentation the Taxpayers submit, and issue a written explanation of its decision -- whether it allows the credit in whole, in part, or denies it again. The Taxpayers then have 90 days from that written decision to file a new appeal if they disagree.

Citations and references

Statutes:

• Va. Code § 58.1-332 A (credit for tax paid to another state; barred when the other state grants a substantially similar credit)
• Va. Code § 58.1-1821 (application for correction of assessment)

Related Department rulings cited:

• P.D. 94-355 (11/23/1994) (dual-residency exception: credit claimed on Virginia return when the reciprocity state does not allow it on a nonresident return)
• P.D. 20-46 (3/18/2020) (credit allowed on Virginia return where taxpayer was an actual California resident)
• P.D. 97-301 (7/7/1997) (credit limited to the lesser of tax paid to the other state or Virginia tax imposed on that income)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-14

Original ruling text

February 16, 2021

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 your clients, * (the “Taxpayers”), for the taxable year ended December 31, 2019.

FACTS

The Taxpayers, a husband and a wife, filed a Virginia resident income tax return for the 2019 taxable year. Under review, the Department denied the credit the Taxpayers claimed for income tax paid to California. The Taxpayers appealed, contending the husband was as an actual resident of California and was thus eligible to claim the credit.

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 or gain from the sale of a capital asset. Further, this code section states:

The credit . . . shall not be granted to a resident individual when the laws of another state, under which the income in question is subject to tax assessment, provide a credit to such resident individual substantially similar to that granted by . . . this section.

As a general rule, Virginia law does not allow a resident to claim a credit on her Virginia return for taxes paid to California because California law allows a Virginia resident to claim the credit on her California nonresident return. (Similarly, a California resident would claim the credit for tax paid to California on her Virginia nonresident return.)

At issue here is which state should allow the out-of-state credit if a taxpayer possesses dual residency. The Department has previously issued a ruling that is relevant to the case at hand. See Public Document (P.D.) 94-355 (11/23/94). In this ruling, the Department determined that when a reciprocity state does not allow a credit on a nonresident return, the taxpayer would claim the credit on their individual Virginia returns.

In the instant case, California law would not permit the Taxpayers to claim a credit for taxes the Taxpayers paid to Virginia if the husband was an actual resident of California. Conversely, Virginia law would not prohibit the credit. The credit, therefore, would be allowed on the Taxpayers’ Virginia return provided the husband was in fact, an actual resident of California. See P.D. 20-46 (3/18/2020).

The Taxpayers should be aware, however, that 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 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. If the husband was an actual resident of California and a domiciliary resident of Virginia, the Taxpayers would be allowed a credit against their Virginia income tax liability for income tax paid to California to the extent permitted by Virginia Code § 58.1-332.

In this case, the Department denied the credit but did not provide a reason when it notified the Taxpayers of their return adjustment. It does not appear, therefore, that the unit making the adjustment considered that the husband may have been an actual resident of California. The case, therefore, will be returned to the unit that made the adjustment for a re-evaluation. That unit must evaluate the Taxpayer’s assertions by requesting relevant documentation such as, for example, a California resident income tax return. The Taxpayer must work further with that unit by providing any documentation requested. Once the documentation is submitted, the unit making the request will review it and adjust the Taxpayer’s Virginia return to the extent warranted. Any action taken by that unit, whether it be to allow the credit in whole or in part or to deny the credit, must be adequately explained to the Taxpayers in writing. Should the Taxpayers wish to appeal the outcome of that review, they will have 90 days from the date of such written communication in which to file an appeal.

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/3535.M

Related Documents

94-355

20-46

97-301