November 24, 2015
Re: § 58.1-1824 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which ***** (the “Taxpayers”) request a refund of individual income tax paid for the taxable year ended December 31, 2012.
FACTS
The Taxpayers, a husband and wife, were Virginia residents that filed a Virginia individual income tax return. The husband was a partner in a multistate partnership. The partnership filed income tax returns on behalf of its nonresident partners, including the husband, in various states including Maryland, North Carolina, and West Virginia. The Taxpayers used the special border state method of calculating the out-of-state credit for income tax paid to these border states. Under review, the Department adjusted the credit and issued an assessment because the Taxpayers had claimed the credit for income tax paid to more than one contiguous state. The Taxpayers paid the additional amount due and filed a claim for refund, contending that they were entitled to claim the credit using the special border state rule because the partnership, rather than the Taxpayers, filed the income tax returns in the border states.
DETERMINATION
Protective Claim
Virginia Code § 58.1-1824 permits any person who has paid an assessment of taxes administered by the Department of Taxation to file a protective claim for refund within three years of the date of an assessment. Pursuant to the authority granted theTax Commissioner under Va. Code § 58.1-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Va. Code § 58.1-1821. As permitted by statute, the Taxpayer's request has been treated as an appeal under Va. Code § 58.1-1821.
Out-of-State Tax Credit
Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state provided the income is either earned or business income or gain on the sale of a capital asset. Virginia law does not necessarily allow a taxpayer to claim a credit for the total amount of tax paid to another state. Rather, the credit is limited to the lesser of the amount of tax actually paid to the other state or the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state. See Public Document (P.D.) 97-301 (7/7/1997). The limitation is computed by multiplying the individual's Virginia tax liability by a fraction, the numerator of which 'is the income upon which the other state's tax is imposed, and the denominator of which is Virginia taxable income.
If certain criteria are met, the limitation that restricts the credit to the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state is disregarded. The special rule will apply if the income subject to tax in a single state contiguous to Virginia is less than Virginia taxable income and all of the income from sources outside Virginia is earned income or business income reported on federal form Schedule C from that single contiguous state. In such instances, the Virginia resident will be entitled to a credit equal to the lesser of: (1) the amount of income tax actually paid to the contiguous state; or (2) 100% of their Virginia income tax liability. See Va. Code § 58.1-332 A.
Even though the special border rule is limited to a single contiguous state, the Taxpayers contend that they were entitled to claim the out-of-state credit for partnership income generated in Maryland, North Carolina, and West Virginia because the partnership filed returns in those states.
The border state credit was enacted in order to address 1989 changes to North Carolina law. As originally enacted, the credit was available only to those Virginia residents who commuted to and earned wages and salaries from employment in North Carolina. In 1998, this credit was expanded to include taxes paid to a single contiguous state on business income of a sole proprietor. See Chapter 291, 1998 Acts of Assembly.
The computation of the border state credit only applies when another state's computation of taxable income results in an amount less than Virginia taxable income. In such cases, the Virginia credit will equal the income tax paid to the other state on the earned income, but it cannot exceed the Virginia individual income tax otherwise payable. Currently, the only contiguous state which has a computation of taxable income resulting in an amount less than Virginia taxable income is North Carolina. As such, the border state rule would not apply to either Maryland or West Virginia.
Further, only earned income (wages and salaries) or business income reported on federal form Schedule C is eligible for the special rule. See P.D. 04-125 (9/16/2004). Because it was reported on federal form Schedule E, the partnership income generated in North Carolina is not eligible for the special border state rule.
After reviewing all the facts and circumstances presented and the applicable law, the Department correctly adjusted the Taxpayer's out-of-state tax credits. Accordingly, the Taxpayers' request for a refund of the additional taxes and interest paid for the 2012 taxable year cannot be approved.
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/1-6090177804.B