I'm a Virginia resident who paid California tax and claimed a credit on my Virginia return -- why did Virginia deny it and tell me to go get the credit from California instead?

Plain-English summary

This ruling explains a genuinely counterintuitive rule for Virginia residents who pay tax to California, Arizona, Oregon, or the District of Columbia: for a small handful of states, Virginia flips the usual credit mechanics around, and the credit has to be claimed on the OTHER state's return instead of Virginia's.

Normally, a Virginia resident who pays income tax to another state on the same income Virginia taxes can claim a credit against Virginia tax for the tax paid elsewhere. But for a short list of "reverse credit" states -- currently Arizona, California, Oregon, and D.C. -- the relationship runs backward: THOSE states let a Virginia resident claim the credit on a nonresident return filed with them, rather than Virginia allowing the credit on the Virginia resident return. California's own tax authority (the Franchise Tax Board) recognizes Virginia as one of these reverse-credit states in its own nonresident credit instructions.

A couple claimed a credit on their Virginia resident returns for income tax they'd paid to California for two consecutive years. The Department denied both credits and issued assessments, because the couple hadn't shown they were actually unable to claim the credit on a California nonresident return instead. The Department's policy allows an exception: if a reverse-credit state limits or blocks its own reciprocal credit in a way that leaves a taxpayer stuck (unable to claim it there either), Virginia will step in and allow the credit on the Virginia return after all, to prevent genuine double taxation. But the couple hadn't demonstrated that kind of block here, so it was premature to conclude they were being double-taxed. The Department's roadmap: file amended California nonresident returns to claim the credit there; if California later denies the credit for some reason OTHER than a missed deadline, the couple can come back to Virginia and seek reinstatement of the credit on an amended Virginia return within one year of California's final decision.

What this means for you

Virginia residents who pay tax to California, Arizona, Oregon, or D.C.

Don't claim the credit on your Virginia return first. For these specific reverse-credit states, the credit generally belongs on a nonresident return filed with the OTHER state. Claiming it on your Virginia return instead will likely be denied unless you can show the other state's own credit mechanism doesn't actually work for your situation.

Anyone worried about genuine double taxation from a reverse-credit state

You're not without recourse if the other state's credit mechanism fails you for reasons unrelated to a missed deadline. File the claim with the other state first; if it's ultimately denied for a substantive reason (not just because you were too late), Virginia gives you a one-year window from that state's final determination to seek the credit back on an amended Virginia return.

Accountants and tax professionals with multi-state clients

Keep the current reverse-credit-state list handy (Arizona, California, Oregon, D.C. as of this ruling) and route the credit claim through the correct state's return the first time -- it avoids an unnecessary Virginia assessment and appeal cycle like the one in this case.

Common questions

Q: I'm a Virginia resident and I paid California tax -- can I claim a credit on my Virginia return?
A: Generally not directly. California is a "reverse credit" state, so Virginia residents generally must claim the credit on a California nonresident return instead. Virginia will only step in if you can show California's credit mechanism genuinely doesn't work for you.

Q: What other states work this same "reverse credit" way?
A: As of this ruling, Arizona, Oregon, and the District of Columbia, in addition to California.

Q: What if California later denies my credit claim?
A: If California denies it for a reason other than missing its own filing deadline, you can seek reinstatement of the credit on an amended Virginia return within one year of California's final determination.

Citations and references

• Va. Code § 58.1-332 A (Virginia resident credit for income tax paid to another state on earned/business income or capital gain)
• Va. Code § 58.1-332 B (nonresident credit against Virginia-source income tax; identifies the reverse-credit relationship with Arizona, California, Oregon, and D.C.)
• Va. Code § 58.1-311.1; § 58.1-1823(v) (one-year window to seek reinstatement of a Virginia credit after the other state's final determination, for reasons other than a missed limitations deadline)
• P.D. 97-98 (2/24/1998); P.D. 07-207 (12/5/2007) (circumstances where the Department has permitted the California credit on a Virginia return); P.D. 95-175 (6/28/1995), P.D. 12-156 (10/4/2012), P.D. 13-118 (6/27/2013) (circumstances where the out-of-state credit was not permitted)

Subject

Credit : Tax Paid to Another State - California

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-31

Original ruling text

February 15, 2022

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessments issued to * (the “Taxpayers”) for the taxable years ended December 31, 2018, and 2019.

FACTS

The Taxpayers, a husband and wife, filed joint resident Virginia income tax returns for the 2018 and 2019 taxable years and claimed credits for income tax paid to California. Under review, the Department denied the credits and issued assessments. The Taxpayers appealed, contending they could claim credit for tax they paid to California as nonresidents and the denial of the credit results in impermissible double taxation.

DETERMINATION

Generally, Virginia Code § 58.1-332 allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or on any gain from the sale of a capital asset. This code section further 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 subsection B of this section.

Under Virginia Code § 58.1-332 B, a nonresident is permitted to claim a credit against tax on income from Virginia sources when their state of residency provides a substantially similar credit to Virginia residents or imposes a tax upon their income derived from Virginia sources but does not tax income earned in the state by Virginia residents. Because it is dependent on another state granting a similar or reciprocal credit, it may be limited by the credit permitted by the other state. Currently, only residents of Arizona, California, Oregon and the District of Columbia may qualify for this credit.

Virginia law generally does not allow a resident to claim a credit on his Virginia return for taxes paid to California because California law allows a Virginia resident to claim the credit on the California nonresident return. Similarly, a California resident would claim the credit for tax paid to California on his Virginia nonresident return. Virginia is one of the few such “reverse credit” states acknowledged by California as indicated in the Franchise Tax Board’s instructions for completing Form 540 Schedule S, Other State Tax Credit.

Under certain circumstances, the Department has permitted a credit for income tax paid to California. See Public Document (P.D.) 97-98 (2/24/1998) and P.D. 07-207 (12/5/2007). The Department has also addressed a number of issues under which the out-of-state credit would not be permitted. See P.D. 95-175 (6/28/1995), P.D. 12-156 (10/04/2012) and P.D. 13-118 (6/27/2013).

In this case, the Taxpayers have not demonstrated that they could not claim the credit on their California nonresident return. In addition, it has been the Department’s policy that when reciprocity states such as California place limits on reciprocity such that taxpayers are unable to claim credit on the nonresident state return, Virginia will allow the credit on the Virginia resident return. As such, it is premature to conclude that this is an instance where the Taxpayers are being subject to double taxation.

Accordingly, based on the information provided, the Department properly disallowed the credit for income tax paid to California on the Taxpayers’ Virginia return. Therefore, the assessments are upheld. The Taxpayers will receive updated bills which will include accrued interest to date. The Taxpayers should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest and possible collections actions.

The Taxpayer should file amended California nonresident returns to claim the credits. If California finds out-of-stare credits claimed are not permitted under California law for reasons other than its statute of limitation, the Taxpayers may seek reinstatement of the credits by filing amended Virginia returns within one year of California’s final determination. See Virginia Code §§ 58.1-311.1 and 58.1-1823 (v).

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/3702.B

Related Documents

97-98

07-207

95-175

12-156

13-118