What does Virginia Ruling of the Tax Commissioner P.D. 21-34 conclude about Subtractions : Foreign Source Income - Tax Cuts and Jobs Act (TCJA)?

Plain-English summary

A Virginia resident individually and wholly owned two controlled foreign corporations (CFCs), and also wholly owned three S corporations that in turn wholly owned four more CFCs. The federal Tax Cuts and Jobs Act's (TCJA) one-time "repatriation" tax under IRC § 965 forced all six CFCs to include extra foreign-source subpart F income, based on their post-1986 accumulated untaxed earnings, for the 2018 tax year. Because S corporations are pass-through entities, that extra income flowed through into the taxpayer's federal adjusted gross income (FAGI), and from there into his 2018 Virginia return.

The taxpayer claimed a Virginia "foreign source income" subtraction for the repatriated income, but the Department disallowed it. He did not appeal that denial -- he accepted it -- but instead asked whether he could pay the resulting Virginia tax bill in installments, mirroring the federal eight-year installment election under IRC § 965(h) (8% of the net liability in each of the first five years, then 15%, 20%, and 25% in years six through eight), because paying the full amount at once would cause him undue hardship.

The Department ruled against the installment request. Virginia Code § 58.1-301 generally conforms Virginia's tax terminology and starting points (FAGI and federal taxable income) to the Internal Revenue Code, but that conformity only reaches items that are actually part of computing FAGI or federal taxable income. The IRC § 965(h) installment election is not part of computing income at all -- it is merely a mechanism for paying an already-determined federal tax liability -- so Virginia's IRC conformity does not pick it up. The Department did note, however, that the taxpayer could still ask the Department's Collections Unit for an ordinary Virginia hardship payment plan, though interest keeps accruing on the unpaid balance under Virginia Code § 58.1-1812 for as long as the plan runs.

On the subtraction itself, the ruling explains (though it was not appealed) that Virginia once allowed a subtraction from FAGI for certain foreign-source income, but the General Assembly repealed that subtraction for tax years beginning on or after January 1, 2003. No such subtraction has existed since, so the Department's denial was correct regardless of the TCJA repatriation issue.

What this means for you

Individuals with S corporations that own foreign subsidiaries

If TCJA repatriation income passed through an S corporation into your FAGI and drove up your Virginia tax bill, do not expect Virginia to recognize the federal IRC § 965(h) eight-year installment election. Virginia's conformity to the IRC only extends to items that are part of computing FAGI or federal taxable income, and a payment mechanism for an already-determined tax liability is not such an item.

Accountants and tax professionals handling repatriation issues

When advising clients on TCJA subpart F/repatriation exposure at the state level, remember that federal payment mechanisms (as opposed to income-computation rules) generally are not imported by state IRC-conformity statutes like Va. Code § 58.1-301. Also note that the old Virginia foreign-source-income subtraction from FAGI was repealed effective for tax years beginning on or after January 1, 2003, so it cannot be used to offset repatriation income reported in any recent tax year.

Taxpayers facing a large one-time state tax bill from federal international tax changes

Even without the federal eight-year election, Virginia's Collections Unit can set up an ordinary hardship payment plan "in certain circumstances" if paying all at once would be a hardship. Unlike the federal installment mechanism, interest continues to accrue on the unpaid Virginia balance throughout the payment plan under Virginia Code § 58.1-1812, so a payment plan reduces the immediate cash strain but does not eliminate the cost of spreading out payment.

Common questions

Q: Can I use the federal IRC § 965(h) eight-year installment schedule to pay Virginia tax on TCJA repatriation income?
A: No. The Department ruled that this election is only a payment mechanism, not part of computing FAGI or federal taxable income, so Virginia's IRC conformity under Va. Code § 58.1-301 does not extend to it.

Q: Is there still a Virginia subtraction for foreign-source income like this repatriated subpart F income?
A: No. Virginia once allowed such a subtraction from FAGI, but the General Assembly repealed it effective for tax years beginning on or after January 1, 2003. It has not been available for years including 2018.

Q: If I cannot use the federal installment election, what options do I have if paying my Virginia bill in full would be a hardship?
A: You can contact the Department's Collections Unit to request an ordinary Virginia payment plan, which the Department allows "in certain circumstances" of undue hardship. Interest continues to accrue on the unpaid balance under Virginia Code § 58.1-1812 for as long as the plan lasts.

Q: Does it matter that the repatriation income came through S corporations rather than directly owned CFCs?
A: Not for this ruling's outcome. Because S corporations are pass-through entities under Va. Code § 58.1-401, income from CFCs owned by the S corporations flowed into the taxpayer's FAGI the same way as income from the CFCs he owned directly, and both were treated the same way for purposes of the subtraction denial and the installment request.

Citations and references

Statutes:

• Va. Code § 58.1-301 (Virginia's conformity to the Internal Revenue Code)
• Va. Code § 58.1-401 (S corporations not subject to Virginia income tax)
• Va. Code §§ 58.1-322.01 through 58.1-322.04 (Virginia individual income tax modifications, including the repealed foreign-source subtraction)
• Va. Code § 58.1-1812 (interest accrual during payment plans)
• IRC § 965(h) (federal eight-year installment election for repatriation tax)
• IRC § 965(i) (S corporation shareholder deferral election)

Related Department guidance cited in the ruling: P.D. 03-54, P.D. 07-1, P.D. 08-103, and P.D. 09-50 (all addressing the repeal of Virginia's foreign-source income subtraction); P.D. 88-165 and P.D. 07-99 (Virginia's treatment of S corporations); Tax Bulletin 19-1 and Tax Bulletin 17-1 (Virginia's conformity date and TCJA-related deconformity provisions).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-34

Original ruling text

March 9, 2021

Re: Request for a Ruling: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessments issued to * (the “Taxpayer”) for the taxable year ended December 31, 2018.

FACTS

The Taxpayer, a Virginia resident, wholly owned three S corporations and two controlled foreign corporations (CFCs). The three S corporations in turn wholly owned four CFCs. The repatriation requirements of the Tax Cuts and Jobs Act (TCJA) resulted in the CFCs including additional foreign source income for the 2018 taxable year. Because the S corporations have elected to be treated as pass-through entities, the additional foreign source income was included in the Taxpayer’s federal adjusted gross income (FAGI).

The Taxpayer claimed a foreign source income subtraction for the repatriated income passed-through the S corporations to him on his 2018 Virginia income tax return. The Department disallowed the subtraction. The Taxpayer does not appeal the denial of the subtraction, but contends that he should be allowed to pay the additional liability in installments pursuant to the TCJA.

RULING

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 Virginia, federal taxable income (FTI) and FAGI, the starting points for determining income taxable in Virginia for corporations and individuals, respectively, are identical to that as defined by the IRC.

S Corporations

In following federal tax policy with respect to S corporations, Virginia Code § 58.1-401 provides that such corporations are not subject to income tax in Virginia. Thus, Virginia has elected to treat S corporations in substantially the same manner as has the Internal Revenue Service (IRS), i.e. the corporate entity itself is not subject to taxation, but the shareholders will be taxed as individuals on their pro rata share of S corporation income to the extent includable in FAGI. See Title 23 of the Virginia Administrative Code (VAC) 10-120-90 E, Public Document (P.D.) 88-165 (6/29/1988) and P.D. 07-99 (6/27/2007).

Subtraction

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 Chapter 3 of Title 58.1 of Virginia Code § 58.1-322.01 through § 58.1-322.04. The Taxpayer claimed a subtraction on his Virginia individual income tax return for repatriated income passed-through his S corporations from the controlled foreign corporations. At one time, Virginia provided a subtraction from FAGI for certain foreign source income. However, the General Assembly repealed the subtraction effective for taxable years beginning on and after January 1, 2003. See P.D. 03-54 (5/3/2003), P.D. 07-1 (2/22/2007), P.D. 08-103 (6/18/2008) and P.D. 09-50 (4/27/2009). Therefore, the subtraction was properly denied.

TCJA

On December 22, 2017, Congress enacted Public Law 115-97, known as the TCJA, which substantially changed the federal income taxation of individuals and businesses. Although the TCJA is typically effective for taxable years beginning in 2018, certain provisions of the act effect prior years.

House Bill 2529 and Senate Bill 1372 (Chapter 17, 2019 Acts of Assembly and Chapter 18, 2019 Acts of Assembly , respectively) were enacted to advance Virginia’s date of conformity to the IRC from February 9, 2018 to December 31, 2018. This legislation allows Virginia to generally conform to the TCJA and the Bipartisan Budget Act of 2018 for the 2018 taxable year and after. Pursuant to Tax Bulletin (VTB) 19-1 (2/15/2019), Virginia will also generally conform to the provisions of the TCJA that affect businesses for the 2018 taxable year and thereafter. It will also continue to deconform from certain provisions of the IRC as explained in VTB 17-1 (2/6/2017).

Multinational companies and individual investors have been keeping some of their foreign profits untaxed by holding such profits abroad in foreign corporations for many years. The TCJA forces the domestic parent corporation (or United States individual shareholder) to pay a one-time income tax, known as “repatriation,” at reduced rates on all their untaxed foreign profits in the 2017 taxable year. The repatriation inclusion under IRC § 965 requires that the gross inclusion of post-1986 accumulated, untaxed earnings and profits (“E&P”) is calculated, which is prescribed as additional subpart F income. United States S corporations that are shareholders of a deferred foreign income corporation may elect to pay may elect to defer payment of their federal income tax derived from repatriation until certain triggering events occur. See IRC § 965(i).

The TCJA allows taxpayers to elect to pay certain income derived from the repatriation of income from foreign corporations by installments over an eight year period. See IRC § 965(h). Taxpayers must pay 8% of their net tax liability for each of first five installments, 15% of the net taxability for the 6th installment, 20% of the net tax liability for the 7th instalment and 25% of the net tax liability for the 8th installment. Because the payment of his Virginia tax liability would cause undue hardship, the Taxpayer requests that he be allowed to satisfy his Virginia income tax liability through the same installment percentages as IRC § 965(h) pursuant to Virginia’s conformity with the IRC.

Virginia conforms to the IRC because FAGI and FTI are the starting point of Virginia taxable income. As such, Virginia’s conformity to the IRC with respect to items that are part of FAGI and FTI. The satisfaction of a taxpayer’s additional federal income tax liability resulting from the repatriation is not part of FAGI or FTI. Rather, it is merely a mechanism for payment. As such, Virginia’s conformity to the IRC does not extend to the allowance of installment payments.

Undue Hardship

The Taxpayer indicates that his payment of his additional Virginia tax liability would cause an undue hardship. The Department allows taxpayers to pay their income tax liability in accordance with a payment plan, in certain circumstances, if the payment causes an undue hardship. The Taxpayer may contact the Department’s Collections Unit at * to arrange a payment plan. Please note that while a payment plan will provide an extended period for payment of the balance due, interest will continue to accrue on the balance until paid, pursuant to Virginia Code § 58.1-1812.

The Code of Virginia sections, regulation, Tax Bulletins 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/3589.B

Related Documents

88-165

03-54

07-1

07-99

08-103

09-50

17-7

19-1