I'm a member of an LLC that claimed a federal research tax credit -- can I still subtract my share of the research expenses on my Virginia individual return?

Plain-English summary

An individual who was a member of a limited liability company (LLC) claimed a subtraction on his 2016-2018 Virginia individual income tax returns for his proportional share of qualified research expenses passed through from the LLC. Under audit, the Department disallowed the subtraction for the 2016 and 2018 years (issuing assessments) and denied a related refund claim for 2017, relying on an older 1994 ruling (P.D. 94-88) that said there was no Virginia adjustment for research expenses.

The general rule and its specific exception. Virginia generally will NOT let a taxpayer subtract an expense that was offset by a federal tax credit unless a Virginia statute specifically allows it -- otherwise the taxpayer would get a double benefit (the federal credit plus a state deduction for the same cost). But Virginia Code § 58.1-322.02 10 is precisely that kind of specific statutory exception for research expenses: under federal law (IRC § 280C(c)), a business that claims the federal research tax credit must correspondingly reduce its deducted research expenses. Virginia's statute lets individuals subtract that reduced (undeducted) amount instead, and expressly extends the subtraction to partners, S-corp shareholders, and LLC members to the same extent it passes through to them for federal purposes.

Why the auditor's reliance on the old ruling was wrong. The 1994 ruling the auditor cited was accurate when written, but Virginia's General Assembly later enacted the research-expense subtraction statute specifically to change that result going forward -- the old ruling's "no adjustment" holding simply doesn't survive a later statutory change on the same topic.

The taxpayer's specific facts. The evidence showed the LLC itself had claimed the federal research credit, and the taxpayer's individual returns subtracted exactly his proportional ownership share of the LLC's total research expenses, consistent with the information the LLC reported. That matched the statute's requirements, so the Tax Commissioner reversed the assessments and ordered the improperly denied refund to be issued.

A related administrative note. The ruling separately reminds taxpayers that when a return shows an overpayment credited toward the following year's estimated tax (an administrative convenience under 23 VAC 10-110-320 C), a LATER Department adjustment to the original return can reduce or eliminate that credit -- the Department will send notice of any such reduction, and it's the taxpayer's job to make sure amounts reported on later returns reflect the corrected credit.

What this means for you

Individuals who are partners, S-corp shareholders, or LLC members

If your pass-through entity claimed the federal research tax credit and reduced its deducted research expenses under IRC § 280C(c) as a result, you can generally subtract your proportional share of those undeducted research expenses on your Virginia individual return -- this is a specifically authorized exception to Virginia's general "no subtraction for federally credited expenses" rule.

Owners who bought into an entity after it claimed the federal credit

The subtraction follows the entity's own reporting to its owners (e.g., Virginia Schedule VK-1) -- if the pass-through entity's forms show the research-expense subtraction amount passing through to you, you're entitled to claim your share regardless of whether you were the original owner who made the underlying research investment decisions.

Anyone whose overpayment was credited to next year's estimated tax

Watch for a Department notice reducing that credit if your original return is later adjusted -- confirm any estimated tax credit you're relying on for a subsequent year's return against the most recent adjustment notice, not just your original filing.

Common questions

Q: Can I subtract research expenses on my Virginia return if my LLC claimed the federal research credit?
A: Yes, if the expenses were reduced/disallowed federally under IRC § 280C(c) because of the credit -- Virginia Code § 58.1-322.02 10 specifically allows individual owners of pass-through entities to subtract their proportional share.

Q: Does it matter that an older Department ruling said there's no research-expense adjustment?
A: Not anymore for years after the subtraction statute was enacted -- that older ruling (P.D. 94-88) predates the statute and doesn't control once the General Assembly created this specific exception.

Q: Does it matter if I wasn't the original owner who made the research investment?
A: No -- what matters is that the pass-through entity's own tax reporting to you supports the subtraction amount you claimed; ownership history doesn't affect your ability to claim your proportional share.

Q: Can the Department reduce an estimated tax credit I'm counting on for next year?
A: Yes -- if your original return is later adjusted, any overpayment credited to next year's estimated tax can be reduced or eliminated, and the Department will notify you of the change.

Subject

Subtractions : Research Expense - Eligibility; Administration : Refund - Estimated tax credit after adjustment

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-49

Original ruling text

April 6, 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, 2016 and 2018, as well as, the denied refund for the taxable year ended December 31, 2017. I apologize for the delay in responding to your request.

FACTS

The Taxpayer filed Virginia individual income tax returns for the 2016 through 2018 taxable years claiming subtractions for qualified research expenses. Under audit, the Department disallowed the subtractions, resulting in assessments being issued for the 2016 and 2018 taxable years and a refund request being denied for the 2017 taxable year. The Taxpayer appeals the assessments and denial of the refund, asserting that he was entitled to the subtractions as originally claimed.

DETERMINATION

Virginia’s conformity to federal income tax law is set forth in Virginia Code § 58.1-301, which provides that the terms used in the Virginia income tax statutes will have the same meaning as used in the Internal Revenue Code (IRC). Further, conformity does not extend to terms, concepts, or principles specifically provided for in Title 58.1 of the Code of Virginia . For Virginia, federal taxable income (FTI) and federal adjusted gross income (FAGI), the starting points for determining income taxable in Virginia for corporations and individuals, respectively, are identical to that as defined by the IRC.

Virginia does not allow a taxpayer to claim a subtraction for expenses offset by a credit at the federal level unless allowed by statute. See P.D. 91-59 (3/29/1991), P.D. 94-164 (5/25/1994), and P.D. 16-34 (3/23/2016). Under Virginia Code § 58.1-322.02 10, individuals are permitted to subtract the amount of qualified research expenses eligible for deduction for federal purposes, but which were not deducted, on account of the provisions of IRC § 280C (c) and which are available to partners, shareholders of S corporations, and members of limited liability companies to the extent and in the same manner as other deductions may pass through to them. See P.D. 18-201 (12/7/2018), and P.D. 19-89 (8/15/2019).

In denying the subtractions, the Department’s auditor relied on P.D. 94-88 (3/25/1994), which states that there is no adjustment for research expenses provided for in the Code of Virginia. However, P.D. 94-88 also notes that legislation was passed by the Virginia General Assembly that would allow a subtraction for research expenses in subsequent years. Statutory changes generally either create new policy, reinforce established policy, or amend existing policy. In this particular case, the General Assembly enacted legislation that changed the applicability of P.D. 94-88 in subsequent taxable years.

The evidence provided shows that the Taxpayer was a member of a limited liability company (LLC), and the LLC claimed a federal tax credit for qualified research. Because of the LLC’s nature as a pass-through entity, a subtraction for the qualified research expenses proportional to the Taxpayer’s ownership interest was available. Consistent with the information on the LLC’s return, the Taxpayer’s individual Virginia income tax returns subtracted the Taxpayer’s proportional share of the total research expenses claimed by the LLC. Pursuant to Virginia Code § 58.1-322.02 10, the Taxpayer is entitled to the subtractions at issue. Accordingly, the adjustments are reversed and a refund will be issued as warranted.

Please note that, as an administrative convenience, the Department allows overpayments of tax to be credited against an estimated tax liability for the next succeeding taxable year when an original income tax return is filed on or before the due date. See Title 23 of the Virginia Administrative Code (VAC) 10-110-320 C. When an individual’s liability is increased as a result of an adjustment to an original return, the credit to estimated payments may be reduced or eliminated. The Department will send a notice of the reduction in the overpayment credit to estimated tax. It is incumbent upon the individual to be aware that the overpayment credit reported on their return may be adjusted by the Department and ensure that any amounts reported on future returns are correct.

The Code of Virginia sections, regulation, and public documents 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 determination, you may contact * in the Office of Tax Policy, Appeals and Rulings at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/ 3351.C

Related Documents

91-59

94-88

94-164

16-34

18-201

19-89