I paid UK tax on income I earned in the United Kingdom -- doesn't the US-UK tax treaty stop Virginia from also taxing that same income? And can penalties and interest be waived because I wasn't sure about the tax rules and COVID delayed things?

Plain-English summary

This ruling corrects a common misunderstanding: international tax treaties negotiated by the federal government generally do NOT bind state tax agencies like Virginia's Department of Taxation -- a lesson delivered here alongside a firm reminder that penalty and interest waivers require genuine, narrowly-defined reasonable cause.

A husband and wife filed their 2018 Virginia resident return in February 2020 but didn't pay the tax shown as due; the Department assessed the unpaid balance plus penalties and interest. The husband, who didn't dispute being a Virginia domiciliary resident, had paid tax to the United Kingdom on income he earned there and argued the United States-United Kingdom Income Tax Convention prevented Virginia from also taxing that same income.

The Department explained why that argument doesn't work: Article 2 of the Convention specifies that it applies only to certain FEDERAL taxes imposed by the U.S. Internal Revenue Code (and the corresponding UK national taxes) -- state and local taxes, including Virginia's, are entirely unaffected by the treaty, a point the Department has made consistently across five prior rulings spanning more than two decades (P.D. 96-228 through P.D. 19-90). Separately, Virginia's own tax code has no provision exempting foreign-earned income from a resident's taxable income at all -- Virginia's tax starts from federal adjusted gross income, and since the UK income was properly part of that FAGI, it was taxable by Virginia with no treaty or statutory exclusion available.

On penalties and interest, the couple asked for a waiver, citing the husband's uncertainty about whether his UK income was taxable in Virginia and delays caused by the COVID-19 pandemic. The Department can waive penalty for "reasonable cause" (Va. Code § 58.1-105), but found none here: a Virginia domiciliary resident's obligation to file and pay is clear regardless of confusion about treaty scope, and -- notably -- the 2018 return's filing deadline came BEFORE the pandemic even began, so COVID-19 couldn't have caused the original delay. Interest fared even worse: it's mandatory under Va. Code § 58.1-1812 and can't be waived at all unless the underlying tax itself is adjusted (interest isn't a penalty, but a fee for the use of money that was properly due to the Commonwealth). Since the couple indicated the assessment would create financial hardship, the Department pointed them toward an offer in compromise (doubtful collectibility) or a payment plan with its Collections Unit as the available paths forward.

What this means for you

Virginia residents earning income abroad and paying foreign tax on it

Don't assume a U.S. tax treaty with the foreign country protects you from Virginia tax on that income. Treaties like the US-UK Convention generally apply only to specified FEDERAL taxes -- state taxes are unaffected, and Virginia has no separate statutory exclusion for foreign-earned income. (Note: this is separate from the credit some Virginia residents can claim for foreign tax paid on PENSION/retirement income under Va. Code § 58.1-332.1 -- a different, narrower provision than a blanket income exclusion.)

Anyone requesting a penalty waiver for reasonable cause

Genuine confusion about whether a treaty or exemption applies generally isn't "reasonable cause" on its own -- your basic filing and payment obligation as a Virginia resident is treated as clear regardless of substantive uncertainty about how much you might owe.

Anyone trying to blame a late assessment or payment on COVID-19

Check the actual dates. If your filing deadline predated the pandemic's onset, COVID-19 can't be the reasonable cause for that original delay -- the Department will look at whether the timeline actually lines up.

Anyone hoping interest will be waived along with penalties

Interest is treated completely differently from penalty -- it's mandatory and can only be reduced if the underlying tax liability itself is adjusted, not through a discretionary reasonable-cause waiver.

Common questions

Q: I paid foreign tax on income I earned abroad -- does a U.S. tax treaty with that country stop Virginia from also taxing it?
A: Generally no. Treaties like the US-UK Income Tax Convention typically apply only to specified federal taxes; state taxes, including Virginia's, are unaffected, and Virginia has no separate statutory exclusion for foreign-earned income by a resident.

Q: Can I get penalties waived if I was genuinely confused about whether my foreign income was taxable in Virginia?
A: Not on that basis alone -- a Virginia resident's filing and payment obligation is treated as clear regardless of confusion about a treaty's scope or an exemption's applicability.

Q: Can COVID-19 be used as a reasonable-cause excuse for a late assessment?
A: Only if the timing actually lines up -- if your filing deadline came before the pandemic began, COVID-19 can't explain a delay that started earlier.

Q: Is interest treated the same as penalty when I request a waiver?
A: No -- interest is mandatory under Virginia law and represents a fee for the use of money properly owed to the Commonwealth. It can't be discretionarily waived; it can only go away if the underlying tax assessment itself is adjusted.

Citations and references

• Va. Code § 58.1-301 (Virginia conforms to IRC terminology/references unless a different meaning is clearly required; Virginia tax starts from federal adjusted gross income)
• United States-United Kingdom Income Tax Convention, Article 2 (the Convention applies only to specified federal-level taxes of the U.S. and UK national governments)
• P.D. 96-228 (9/9/1996), P.D. 07-39 (4/20/2007), P.D. 13-232 (12/18/2013), P.D. 18-75 (5/2/2018), P.D. 19-90 (8/15/2019) (consistent Department position that international tax treaties do not bind Virginia or other state/local taxes)
• Va. Code § 58.1-105 (Department may waive penalty upon a showing of reasonable cause)
• Va. Code § 58.1-1812 (interest on tax underpayments is mandatory and represents a fee for use of money, not a penalty)

Subject

FAGI : Foreign Income Exclusion - United Kingdom; Administration : Penalty and Interest - Waiver for Reasonable Cause

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-51

Original ruling text

March 22, 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 assessment issued to * (the “Taxpayers”) for the taxable year ended December 31, 2018.

FACTS

The Taxpayers, a husband and wife, filed a Virginia resident income tax return for the 2018 taxable year in February 2020. Because the Taxpayers did not pay the tax shown as due with the return, the Department issued an assessment for the balance of unpaid tax, including penalties and interest. The Taxpayers appeal, contending the assessment should be abated because the income was already taxed in the United Kingdom. The Taxpayers also request that penalties and interest be waived on the assessment.

DETERMINATION

Assessment of Tax

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 individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (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 .

The husband does not dispute that he was a domiciliary resident of Virginia for the 2018 taxable year. As such, any income properly included in his FAGI would also have been included in his Virginia taxable income unless specifically exempted. There is currently no provision in the Code of Virginia that provides for an exemption for foreign income earned by a Virginia resident.

The husband paid tax to the United Kingdom on the income earned in the United Kingdom. He believes that Virginia should not tax that income because the United States – United Kingdom Income Tax Convention (the “Convention”) prevents double taxation.

Article 2 of the Convention states, in pertinent part, “The existing taxes to which this Convention shall apply are . . . in the case of the United States, the Federal income taxes imposed by the Internal Revenue Code . . . .” Pursuant to this article, the Convention applies only to certain taxes imposed at the federal level by the United States and the United Kingdom national governments. Taxes imposed by state and local governments, including Virginia, are unaffected by the Convention. See Public Document (P.D.) 96-228 (9/9/1996), P.D. 07-39 (4/20/2007), P.D. 13-232 (12/18/2013), P.D. 18-75 (5/2/2018), and P.D. 19-90 (08/15/2019).

Interest and Penalty Waiver

The Taxpayers request that the Department waive penalties and interest included with the assessment because the husband was unsure about the taxability of his income in Virginia and the COVID-19 pandemic contributed to the delay. Virginia Code § 58.1-105 grants the Department the authority to waive penalty in cases where reasonable cause is demonstrated. A Virginia domiciliary resident’s requirement to file a Virginia income tax return is clear, and the filing deadline for the 2018 taxable year occurred prior to the onset of the pandemic. Based on the circumstances presented, the Department does not find reasonable cause to waive the penalties.

In addition, the application of interest to tax underpayments is mandatory under Virginia Code § 58.1-1812, and it cannot be waived unless the associated tax is adjusted. Interest is not assessed as a penalty, but represents a fee for the use of money that was properly due the Commonwealth. As such, the Department finds no basis for abating any portion of the assessed interest.

CONCLUSION

Because the husband was a domiciliary resident of Virginia, he was required to include his entire FAGI when calculating his Virginia taxable income. Neither the Code of Virginia nor the Convention provide a basis for excluding his income earned in the United Kingdom from FAGI for Virginia income tax purposes. Further, there is no basis for abating the penalties or interest previously assessed. The assessment, accordingly, must be upheld.

The Taxpayers will receive an updated bill that 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 collection actions.

The Taxpayers indicated that the assessment will create a financial hardship. If the assessment creates a financial hardship, the Taxpayers may pursue an offer in compromise based on doubtful collectibility. To begin that process, the Taxpayers should complete the enclosed Individual Offer in Compromise: Doubtful Collectibility form and Financial Statement for Individuals, and include the required fee or fee waiver request. The completed forms and statement will allow the Department to review and analyze the Taxpayers’ financial situation. Upon completion of that review, a response will be issued to the Taxpayers. The Taxpayers also have the option to request a payment agreement with the Department’s Collections Unit. The Collections Unit may be contacted at *.

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/3991.X

Related Documents

96-228

07-39

13-232

18-75

19-90