The IRS increased our federal income and Virginia adjusted our return to match -- so why did our Virginia taxable income go up by MORE than our federal income did?

Plain-English summary

The IRS told Virginia that a couple hadn't included all of their income in federal adjusted gross income (FAGI) on their 2017 federal return. Because they hadn't filed an amended Virginia return to reflect the federal correction, the Department assessed the additional Virginia tax due on its own, as the law allows once a year has passed without a taxpayer-filed amendment. The couple appealed, but not on the substance of the IRS's correction -- they wanted to know why their Virginia taxable income had gone up by more than their FAGI had.

The answer lies in how Virginia's age-65-and-older deduction is structured. Virginia starts its tax computation from FAGI, so any increase there flows straight through to Virginia taxable income dollar for dollar. But taxpayers 65 or older can also claim up to a $12,000 age deduction -- and that deduction shrinks by $1 for every $1 that adjusted FAGI exceeds $50,000 (single filers) or $75,000 (married filers). For a couple already near or past that threshold, an increase in FAGI does double duty: it raises Virginia taxable income once directly, and a second time by proportionally shrinking the age deduction they'd otherwise be entitled to. That's exactly what happened here -- the IRS's FAGI increase (paired with a reduced itemized medical expense deduction) triggered both effects, so the couple's Virginia taxable income rose by more than the federal change alone would suggest. The Department found the math correct and upheld the assessment.

What this means for you

Taxpayers 65 or older near the age-deduction phaseout threshold

If your adjusted FAGI is close to $50,000 (single) or $75,000 (married), be aware that any additional income -- whether from an audit adjustment, a late-discovered 1099, or anything else -- can affect your Virginia bill twice: once as ordinary income, and again by shrinking your age deduction. Don't assume a federal adjustment will translate one-for-one into your Virginia liability.

Anyone who receives an IRS adjustment notice and is unsure why their Virginia bill changed by more than expected

This ruling is a clear, worked illustration of how a Virginia-specific deduction phaseout can amplify an otherwise simple federal change. If the numbers don't seem to add up, check whether an income-sensitive deduction (like the age deduction, or Virginia's other phased-out benefits) is doing double work in the background before assuming an error.

Anyone who receives a federal adjustment and hasn't yet told Virginia

Virginia Code § 58.1-311 requires you to file an amended Virginia return within one year of a final federal change. If you don't, the Department can assess the correct tax at any time under § 58.1-312 A 3 -- there's no separate statute-of-limitations shelter for staying silent about a federal correction.

Common questions

Q: Why did my Virginia taxable income go up by more than my federal adjusted gross income did?
A: If you claim Virginia's age-65 deduction and your adjusted FAGI is above the phaseout threshold ($50,000 single / $75,000 married), an FAGI increase both raises your taxable income directly and further shrinks that deduction dollar-for-dollar -- producing a larger-than-expected increase in Virginia taxable income.

Q: How long do I have to report a federal income tax change to Virginia?
A: One year from the date the federal change or correction becomes final, by filing an amended Virginia return, under Va. Code § 58.1-311.

Q: What happens if I don't file an amended Virginia return after a federal change?
A: The Department can assess the correct additional tax at any time -- there's no limitations period protecting an unreported federal change, per Va. Code § 58.1-312 A 3.

Citations and references

• Va. Code § 58.1-301 (Virginia conforms to IRC terminology and starts VTI computation with FAGI)
• Va. Code § 58.1-311 (duty to report federal changes within one year via an amended return)
• Va. Code § 58.1-312 A 3 (Department may assess at any time if no amended return is filed for a federal change)
• Va. Code § 58.1-322.03 5 (age 65+ deduction of up to $12,000, reduced $1 for $1 above $50,000 single / $75,000 married adjusted FAGI)
• IRC § 6103(d) (authorizes the Department to obtain federal return information from the IRS)

Subject

Administration : Assessment - Federal Changes, Statute of Limitations; Deduction : Age - Threshold for Faze Out

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-19

Original ruling text

January 25, 2022

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you protest the individual income tax assessment issued to * (the “Taxpayers”) for the 2017 taxable year. I apologize for the delay in responding to your request.

FACTS

The Department received information from the Internal Revenue Service (IRS) indicating that the Taxpayers failed to include all their income in federal adjusted gross income (FAGI) on their federal return for the 2017 taxable year. Because the Taxpayers had not filed an amended Virginia income tax return to report the federal changes, an assessment was issued for the additional tax due. The Taxpayers appealed, contending that the Department did not explain why their Virginia taxable income (VTI) increased more than their FAGI.

DETERMINATION

Federal Changes

Virginia Code § 58.1-301 provides, with certain exceptions, that the 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 VTI with FAGI. 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 the Code of Virginia .

Virginia Code § 58.1-311 requires an individual to report a change or correction in federal taxable income within one year of the final determination of such change or correction by filing an amended return with the Department. If a taxpayer fails to file an amended return, Virginia Code § 58.1-312 A 3 permits the Department to assess the appropriate tax at any time.

In addition, IRC § 6103(d) authorizes the Department to obtain information from the IRS that will assist in determining any additional tax liability. In this case, the information obtain by the Department indicates that the IRS increased the Taxpayers’ FAGI and reduced the Taxpayers’ allowable itemized medical expense deduction for the 2017 taxable year. Accordingly, the Department corrected their Virginia return to reflect the changes.

Age Deduction

Under Virginia Code § 58.1-322.03 5, taxpayers born after January 1, 1939 who have attained the age of 65 may claim a deduction for up to $12,000. However, the amount of this deduction is reduced by $1 for every $1 that adjusted FAGI exceeds $50,000 for single taxpayers or $75,000 for married taxpayers. For the purpose of calculating the deduction, adjusted FAGI means FAGI minus any benefits received under Title II of the Social Security Act and other benefits subject to federal income tax solely under IRC § 86.

In this case, the Taxpayers’ adjusted FAGI exceeded the threshold provided by the statute. As such, for every $1 their FAGI increased, their age deduction was also reduced $1. Thus, because of the manner in which the age deduction is computed, the increase in FAGI effectively caused a double increase in VTI. That is because not only did the increase in FAGI cause a corresponding and equal increase in VTI, the dollar for dollar reduction of the age deduction also increased VTI by the same amount again.

CONCLUSION

In accordance with the information received by the IRS, the Department correctly increased the Taxpayers’ FAGI, reduced their itemized medical expense deduction, and reduced their age deduction for the 2017 taxable year. As such, the 2017 assessment is upheld and remains due and payable.

The Taxpayers will receive an updated bill with accrued interest to date. The bill should be paid within 30 days of the bill date to avoid the accrual of additional interest and possible collections actions.

The Code of Virginia sections 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/3478-C

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