July 28, 2016
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 your clients, ***** (the “Taxpayers”), for the taxable year ended December 31, 2014. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayers, a husband and a wife, filed a joint Virginia resident individual income tax return for 2014 taxable year and claimed a credit for payment of the New York Metropolitan Commuter Transportation Mobility Tax (the “NY MCTMT”). Under review, the Department disallowed the credit and issued an assessment. The Taxpayers filed an appeal, contending that the Department's policy of denying a credit for payment of the NY MCTMT is erroneous because the NY MCTMT is a tax based upon income. The Taxpayers also argue that denying credit for payment of the NY MCTMT violates the Commerce Clause of the United States Constitution.
DETERMINATION
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. In 2012, the General Assembly enacted Senate Bill 681 (Chapter 292, 2012 Acts of Assembly), effective for taxable years beginning on or after January 1, 2007, to clarify and restore the Department's long-standing policy of allowing a credit only for income taxes that are similar to Virginia's individual income tax. See Public Document (P.D.) 12-108 (7/1/2012).
Virginia Code § 58.1-332.2 B clarifies the circumstances in which a franchise, license, business, or occupational tax will not qualify as an income tax. A tax does not necessarily need to be a franchise, license, excise, business, or occupational tax to be disqualified for purposes of the out-of-state credit. Virginia Code § 58.1-332.2 C provides that “[t]he credits in §§ 58.1-332 and 58.1-332.1 shall apply only when the tax imposed in the other state or foreign country is substantially similar to the tax imposed by Article 2 (§ 58.1-320 et seq.), as defined by this section.” (Emphasis added). Thus, a tax, regardless of type, must still be substantially similar to the Virginia individual income tax imposed under Va. Code § 58.1-320 et seq., which applies generally to all of the income of Virginia residents and all of the income of nonresidents sourced to Virginia.
The NY MCTMT is a state-administered tax imposed on employers and self-employed individuals who engage in business within the metropolitan commuter transportation district (the “MCTD”), which comprises certain counties in the New York City metropolitan area. The tax is administered by the State of New York for the benefit of the Metropolitan Transportation Authority, which receives the proceeds of the tax to preserve, operate, and improve transportation in that district. In this case, the husband was a partner in a partnership that operated within the MCTD. The Taxpayers argue that it is unreasonable to construe the MCTD as anything other than an income tax because it was imposed at a specific rate on the husband's net earnings from self-employment. The Taxpayers argue that this methodology essentially taxed the net income from the partnership allocated to each partner.
In P.D. 13-185 (10/18/2013), the Department noted that the NY MCTMT was unlike Virginia's income tax in a number of ways. The Department observed that for employers, the NY MCTMT was not based on income at all. Rather, it was based on payroll expenses for “covered employees” under the rules and regulations of the agency administering the tax. Even for self-employed individuals, it only applied to net earnings from self-employment that were attributable to the MCTD, rather than to all types of income. As such, the Department concluded that it more closely resembled federal payroll and self-employment taxes rather than the income tax set forth in the Internal Revenue Code (IRC) upon which Virginia's individual income tax is based.
The Department also observed that the NY MCTMT differed from Virginia's individual income tax in that it was earmarked for a particular purpose in particular localities in New York and taxpayers were only subject to it to the extent they engaged in business activities in the MCTD. By contrast, Virginia's individual income tax is not earmarked for any particular purpose or locality, and taxpayers are not required to have nexus with a particular Virginia locality in order to be subject to it. Because of these differences, the Department held in P.D. 13-185 that the NY MCTMT was not an income tax substantially similar to Virginia's income tax, and thus was not an out-of-state income tax that qualified for the credit under Va. Code § 58.1-332.
Commerce Clause
The Taxpayers also contend that the Department must grant a credit for the NY MCTMT to avoid violating the Commerce Clause of the United States Constitution. They have cited Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787 (2015) in support of this contention.
It is well established that a state may tax all the income of a resident, even income from outside the taxing jurisdiction. In People of State of New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937), the United States Supreme Court explained “[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized.” In Wynne, however, the Supreme Court also recognized that a state's taxation of a resident's income may be subject to constitutional scrutiny under the Commerce Clause of the U.S. Constitution.
The Commerce Clause, grants Congress power to “regulate Commerce . . . among the several States.” Art. I, § 8, cl. 3. Although the Clause is framed as a positive grant of power to Congress, the Court has consistently held this language to contain a further, negative command, known as the dormant Commerce Clause. Wynne, 135 S. Ct. at 1794. The dormant Commerce Clause prohibits state taxation discriminating against interstate commerce, even when Congress has failed to legislate on the subject. Id. To help identify state tax schemes that discriminate against interstate commerce, the Court uses something known as “the internal consistency test.” Id. at 1803. The test “looks to the structure of the tax at issue to see whether its identical application by every State in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate.” Wynne, 135 S. Ct. at 1803 (citations and internal quotation marks omitted).
Accordingly, a state is well within its authority to impose income tax on all of the income of a resident of that state. A state need only ensure that the income tax, to the extent that it substantially affects interstate commerce, does not discriminate against such commerce. While granting a credit against a resident's income tax may cure an otherwise discriminatory tax, the Supreme Court in Wynne did not order that. In fact, the Court noted that alternative remedies existed, one of which would be for the state to refrain from taxing nonresidents on certain income. Wynne, 135 S. Ct. at 1806.
Critically, not all situations of double taxation are a result of discriminatory tax schemes. The Court explained:
By hypothetically assuming that every State has the same tax structure, the internal consistency test allows courts to isolate the effect of a defendant State's tax scheme. This is a virtue of the test because it allows courts to distinguish between (1) tax schemes that inherently discriminate against interstate commerce without regard to the tax policies of other States, and (2) tax schemes that create disparate incentives to engage in interstate commerce (and sometimes result in double taxation) only as a result of the interaction of two different but nondiscriminatory and internally consistent schemes... The first category of taxes is typically unconstitutional; the second is not.
Id. (citations omitted).
If a court were to subject Virginia's credit to the internal consistency test it would assume that all states, including New York, imposed a broad-based income tax like Virginia's and would not analyze the actual taxes imposed by each of the other states. Under that assumption Virginia would grant the credit for income taxes imposed by the other states and no discrimination would be found to exist that could be attributed to Virginia's tax structure. The fact that a credit has been denied for the NY MCTMT is attributable to the fact that New York has imposed a tax that is significantly different from Virginia's income tax. This situation fits into the second type of result of the internal consistency test, which does not violate the Commerce Clause of the U.S. Constitution.
CONCLUSION
Pursuant to the Department's policy set forth in P.D. 13-185, I find that the Department properly denied credit on the Taxpayers' 2014 Virginia income tax return for payment of the NY MCTMT. In addition, in the Department's opinion, denial of credit for the NY MCTMT does not violate the Commerce Clause of the U.S. Constitution. Accordingly, the assessment is upheld. Because the Taxpayers have paid the balance due on the assessment, no further action is required.
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/1-6165110030.M