Can a Virginia resident claim a credit for tax paid to Pennsylvania on fees earned as trustee and power of attorney for a family member, even though the Pennsylvania-Virginia reciprocity agreement doesn't apply and the income was reported as 'other income' on the federal return?

Subject

Credit: Tax Paid to Another State - Pennsylvania Income: Earned - Trustee and Power of Attorney for a Family Estate

Plain-English summary

A Virginia resident (the "Taxpayer") filed a 2018 Virginia individual income tax return claiming a credit for tax she paid to Pennsylvania on fees she earned serving as trustee for a family member's estate and as power of attorney (POA) for an incapacitated family member. The Department of Taxation denied the credit and assessed additional tax, reasoning that (1) Virginia and Pennsylvania have a reciprocity agreement that could make the income exempt rather than credit-eligible, and (2) the income was not the type that qualifies for the out-of-state tax credit.

The Tax Commissioner sided with the Taxpayer and abated the assessment. First, the reciprocity agreement between Virginia and Pennsylvania (authorized by Va. Code § 58.1-342 B) only covers "compensation" earned by employees -- wages, salaries, commissions, and similar pay for personal services under Va. Code § 58.1-302. Because the Taxpayer was not an employee, she did not earn "compensation," so reciprocity did not apply to her situation at all.

Second, on the out-of-state tax credit itself, the Department's own auditor had denied the credit because the Taxpayer reported the trustee/POA fees as "other income" on her federal return rather than as wages or self-employment income. The Commissioner rejected that reasoning: how income is labeled on the federal return doesn't control whether it qualifies for Virginia's credit. Title 23 VAC 10-110-221 defines "earned income" eligible for the credit to include "other amounts received as compensation for professional services actually rendered," and the Commissioner found that the Taxpayer's trustee and POA services were essentially the same kind of professional services a law firm or trust company would provide. Because she was liable for tax on this earned income in both Virginia and Pennsylvania, she qualified for the credit under Va. Code § 58.1-332 A, and the assessment was abated.

What this means for you

Individuals serving as trustee, executor, or power of attorney for family members

If you're paid a fee for serving as a nonprofessional trustee, executor, or power of attorney -- even for a relative's estate rather than as part of a business -- and you pay income tax on that fee to another state, this ruling shows Virginia may treat those fees as "earned income" eligible for the out-of-state tax credit. The fact that the fee gets reported as "other income" on your federal Form 1040 does not automatically disqualify it.

Accountants and tax preparers

Don't assume the out-of-state tax credit is unavailable just because a client's cross-state income was reported as federal "other income" rather than on a wages or business-income line. This ruling confirms that Title 23 VAC 10-110-221's definition of earned income -- "amounts received as compensation for professional services actually rendered" -- looks at the substance of the services performed (here, fiduciary/agency services comparable to those of a law firm or trust company), not the federal reporting label.

Taxpayers relying on the Virginia-Pennsylvania reciprocity agreement

Don't conflate the reciprocity agreement with the out-of-state tax credit -- they are different mechanisms. Reciprocity under Va. Code § 58.1-342 B only exempts employee compensation (wages, salaries, commissions) from tax in the nonresident work state. If you're not an employee -- for example, if you're paid a fiduciary fee rather than wages -- reciprocity simply doesn't apply, but you may still separately qualify for the ordinary out-of-state tax credit on that income.

Common questions

Q: Why didn't the Pennsylvania-Virginia reciprocity agreement cover this income?
A: Reciprocity under Va. Code § 58.1-342 B and Va. Code § 58.1-302 applies only to "compensation" -- wages, salaries, commissions, and similar pay to employees for personal services. The Taxpayer was not an employee, so the fees she received as trustee and POA were not "compensation" and reciprocity did not apply.

Q: Why did the Department's auditor originally deny the credit?
A: The auditor concluded the Taxpayer wasn't eligible because she reported the fees as "other income" on her federal income tax return, rather than as wages or professional fees.

Q: Why did the Tax Commissioner overturn that denial?
A: Because Title 23 VAC 10-110-221 defines the "earned income" that's eligible for the out-of-state tax credit, and that definition -- not how the income happens to be labeled on the federal return -- governs credit eligibility. The regulation's definition of earned income includes "other amounts received as compensation for professional services actually rendered," and the Commissioner found the Taxpayer's trustee and POA services were essentially professional services comparable to those of a law firm or trust company.

Q: What is "other income" on a federal return, and why did it come up here?
A: The ruling explains that the federal return's "other income" line covers items like prizes, gambling winnings, hobby receipts, and fees from serving as a nonprofessional fiduciary (such as an executor or POA) when the person isn't engaged in a trade or business providing those services. The Taxpayer's trustee/POA fees fell into this "other income" category on her federal return, which is what led the auditor to (incorrectly) deny the state credit.

Q: What was the final outcome?
A: The Tax Commissioner concluded the Taxpayer earned income from professional services performed outside Virginia and was liable for income tax to both Virginia and Pennsylvania on that income. She was therefore eligible for the out-of-state tax credit under Va. Code § 58.1-332 A, and the Department abated the assessment.

Citations and references

Statutes:

• Va. Code § 58.1-1821 (appeal of an individual income tax assessment)
• Va. Code § 58.1-342 B (authority to enter reciprocal agreements with other states)
• Va. Code § 58.1-302 (definition of compensation for reciprocity purposes)
• Va. Code § 58.1-332 A (credit for tax paid to another state)
• Title 23 VAC 10-110-221 (definition of earned income eligible for the out-of-state tax credit)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-22

Original ruling text

February 23, 2021

Re: § 58.1-1821 Appeal: 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, 2018.

FACTS

The Taxpayer filed a 2018 Virginia resident individual income tax return, claiming a credit for taxes paid to Pennsylvania on income received for serving as a trustee for a family member’s estate and as a power of attorney (POA) for an incapacitated family member. Under review, the Department denied the credit and issued an assessment. The Department maintained that the credit was not available because of the reciprocity agreement between Pennsylvania and Virginia and because the income at issue was not eligible for the out of state tax credit. The Taxpayer appealed, contending she is eligible to claim the credit.

DETERMINATION

Reciprocity

Virginia Code § 58.1-342 B grants the Department the authority to enter into reciprocal agreements with other states to exempt nonresidents from the Virginia income tax when they earn compensation from working in Virginia if such other states similarly exempt Virginia residents. In addition, employers are not required to withhold Virginia income tax from residents of these states. Virginia currently has this type of agreement with Pennsylvania.

Compensation means wages, salaries, commissions and any other form of remuneration paid or accrued to employees for personal services. See Virginia Code § 58.1-302. In this case, the Taxpayer was not an employee and, therefore, did not earn compensation.

Other Income

The federal income tax return includes a line for other income that is taxable but does not generally occur often enough to warrant its own line. The items of income reported on this line include most prizes and awards, gambling winnings, hobby receipts, rent from personal property not used in a trade or business, distributions from health or education savings accounts, taxable portions of disaster relief, recoveries of certain deductions, cancellation of debt, and fees resulting from services performed as a nonprofessional fiduciary. With regard to a nonprofessional fiduciary or personal services representative, fees are reported as other income on the return when received by an individual who is not engaged in a trade or business for the provision of such services. Such services can include acting as an executor of a friend’s or relative’s estate or authority to make decisions for another individual ( i.e . Power of Attorney or Medical Power of Attorney).

Out of State Tax Credit

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. To claim the credit, the income must be 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. Title 23 of the Virginia Administrative Code (VAC) 10-110-221 defines earned income for purposes of the credit to include wages, salaries, or professional fees and other amounts received for services actually rendered.

The Department’s auditor concluded that the Taxpayer was not eligible for the credit because the income was reported as “other income” on her federal income tax return. For purposes of the out-of-state tax credit, however, Title 23 VAC 10-110-221 B defines income eligible for the credit. Thus, the manner in which income is reported on a federal income tax return does not govern whether tax on such income can qualify for the credit. Under the regulation, “earned income” includes “other amounts received as compensation for professional services actually rendered.” In her capacity as trustee and POA, the services provided by the Taxpayer were essentially the same as professional services obtained from a law firm or trust company.

CONCLUSION

The Taxpayer earned income from professional services conducted outside of Virginia and became liable for income tax to both Virginia and Pennsylvania. As such the Taxpayer was eligible to claim the out of state tax credit, and the assessment at issue will be abated.

The Code of Virginia sections and regulation cited are available online at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s website. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2227-C