April 26, 2017
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, 2015.
FACTS
The Taxpayers, a husband and a wife, filed a Virginia resident individual income tax return for the 2015 taxable year and subtracted the income the husband received as a member of a local school board. The Taxpayers claimed the subtraction under Va. Code § 58.1-322 C 24, for salaries of federal and state employees under $15,000. The Department denied the subtraction on the basis that the husband was not a federal or state employee and issued an assessment. The Taxpayers appeal, contending the husband was entitled to deduct uncompensated business expenses because he was a “statutory employee.”
DETERMINATION
Statutory Employee
The husband asserts that he was a “statutory employee” and thus was eligible to deduct uncompensated business expenses from his school board wages. The term “statutory employee” commonly refers to individuals in certain named occupational groups described in Internal Revenue Code (IRC) § 3121(d)(3) who would normally be independent contractors under common law but who are employees for federal employment tax purposes under the Federal Insurance Contributions Act (FICA). See Rev. Rul. 90-93, 1990-2 CB 33.
As a school board member, the husband was not in one of the occupational groups described in IRC § 3121(d)(3). In any event, the school district categorized the husband as a statutory employee on his 2015 Wage and Tax Statement (Form W-2).
IRC § 162(a) allows a taxpayer to deduct all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. For this purpose, the term “trade or business” includes the performance of the functions of a public official. See IRC § 7701(a)(26). In addition, statutory employees are permitted to file federal Schedule C to report their income and associated expenses from such employment. Because his expenses exceeded his income, the husband reported a loss on his Schedule C that was included in his computation of federal adjusted gross income (FAGI). The Department will express no opinion concerning the classification of the husband as a statutory employee or his use of a Schedule C to report his school board income and expenses.
On their Virginia return, the Taxpayers then subtracted his school board income from FAGI in computing their Virginia taxable income. The Department did not make any adjustments to the expenses reported on the Schedule C. Instead, the Department denied the subtraction the Taxpayers claimed for the husband's school board income on the basis that the husband was not a federal or state employee as required under Va. Code § 58.1-322 C 24.
Subtraction for Income of Federal and State Employees
By reason of their character as legislative grants, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell's Motor Freight, Inc., et al. v. Virginia Dep't of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983). Virginia Code § 58.1-322 C 24 allows a subtraction for:
Effective for all taxable years beginning on and after January 1, 2000, the first $15,000 of salary for each federal and state employee whose total annual salary from all employment for the taxable year is $15,000 or less.
The statutory language first grants a subtraction (“the first $15,000 of salary for each federal and state employee”), then imposes a restriction (“whose total annual salary from all employment for the taxable year is $15,000 or less”). If the husband was a “federal or state employee,” then he is granted the subtraction, subject to the limiting condition imposed by the last clause.
The term “state employee” is undefined for the purposes of this subtraction. A broader examination of the Code of Virginia, however, indicates that state employees are frequently distinguished from local employees and officials. For example, the definition of “state employee” used in Chapter 1 of Title 51.1 of the Code of Virginia pertaining to the Virginia Retirement System (VRS) expressly excludes local officers and employees of political subdivisions of the Commonwealth. See Va. Code § 51.1-124.3. Because they are corporate entities that are created by, and whose powers are also defined by, state law, school boards would be considered political subdivisions as defined by Va. Code § 51.1-124.3. In Va. Code § 51.1-700, state and local employees are distinguished for purposes of certain state law provisions pertaining to federal social security benefits for such employees. Another example where state and local employees are distinguished is in the context of health plans for such employees, which are governed by separate statutory provisions. See Va. Code §§ 2.2-2818 and 2.2-1204, respectively. Finally, Va. Code § 22.1-63 separately identifies state employees from other individuals who perform governmental services and are ineligible to hold the office of school district superintendent, including school board members. This last example is a strong indication that the General Assembly draws a distinction between state employees and school board members. If school board members were considered state employees, it would not have been necessary for the General Assembly to name them as a separate category ineligible to hold the office of superintendent. In the Department's opinion, therefore, school board members are not state employees for purposes of the subtraction under Va. Code § 58.1-322 C 24.
Even if the husband could have been classified as a state employee, the subtraction under Va. Code § 58.1-322 C 24 is only available to the extent the income was included in FAGI. Because his associated expenses exceeded his school board income, he reported a loss from his school board activities on his federal income tax return. As a result, the income was effectively eliminated in his FAGI prior to being reported on the Virginia income tax return. Allowing a subtraction for income that was already entirely offset by expenses would result in a double benefit.
Accordingly, the Department finds that the subtraction for state employee income was properly disallowed. The Taxpayers will receive an updated bill, 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.
The Code of Virginia sections 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/1119.M