May 19, 2020
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek a refund of Virginia individual income tax paid by ***** (the “Taxpayers”) for the taxable year ended December 31, 2005. I apologize for the delay in responding to your request.
FACTS
The Taxpayers incurred a casualty loss in the 2008 taxable year as a result of a Ponzi scheme. For federal income tax purposes, the Taxpayers carried back the 2008 loss five taxable years. They filed amended Virginia individual income tax returns for the 2006 and 2007 taxable years in which they carried back the loss two taxable years. The Department issued refunds based on the Taxpayers’ amended returns.
Because Virginia does not conform to all federal net operating loss (NOL) carryback rules, there was a difference between the federal adjusted gross income (FAGI) reported on the Federal and Virginia returns. In July 2014, the Taxpayers received a notice from the Department of a proposed assessment related to the casualty loss carryforward for the 2011 taxable year. In response, the Taxpayers contacted the Department in order to properly determine the carryback amounts. After working with the Taxpayers, the Department’s auditors concluded the casualty loss should have been carried back three taxable years and the remaining amount of the loss could be carried forward through the 2012 taxable year. Because the loss could be carried back three years, the Taxpayers filed an amended 2005 Virginia return requesting a refund.
The Department denied the refund request for the 2005 taxable year on the basis that the amended return was filed outside the applicable statute of limitations period. The Taxpayers appealed, contending the Department did not timely address the amended returns nor provide proper guidance on the calculation of the casualty loss.
DETERMINATION
Net Operating Loss
Virginia income tax laws do not address the computation or application of casualty losses. Nonetheless, Virginia Code § 58.1-301 provides that the terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code (IRC), with certain exceptions, unless a different meaning is clearly required. For individual income tax purposes, Virginia clearly “conforms” to federal income tax law in that it starts the computation of Virginia taxable income (VTI) with federal adjusted gross income (FAGI).
Under legislation enacted by the 2019 General Assembly, Virginia’s date of fixed conformity to the terms of the IRC was advanced from February 9, 2018 to December 31, 2018. See Tax Bulletin (VTB) 19-1 (2/15/2019). As a result, Virginia will generally conform to the individual income tax provisions of Tax Cuts and Jobs Act (the “TCJA”), including the imposition of an 80% of taxable income limitation on the net operating loss deduction (NOLD), the repeal of the NOL carry back provisions, the ability to indefinitely carry forward NOLs, and the elimination of the deduction for casualty losses other than for losses incurred in a federally-declared disaster area.
The Department’s regulation, effective January 1, 1985, explains how an NOL is treated under Virginia’s conformity to IRC § 172. See Title 23 of the Virginia Administrative Code (VAC) 10-110-84. Under the regulation, Virginia generally allows federal NOLDs to be carried back for the same period as is allowed under the IRC, unless an election is made to carry the NOL forward.
Several exceptions to the regulation have been enacted by the General Assembly. Virginia did not conform to the five-year carry back for the taxable years ending on or after January 1, 2001, and before January 1, 2003 permitted under the Job Creation and Worker Assistance Act of 2002 (The “2002 Act”). See Tax Bulletin (VTB) 02-3 (4/8/2002). Virginia also declined to conform to the 3, 4, or 5-year NOL carryback for an applicable 2008 loss under the American Recovery and Reinvestment Act of 2009 (the “2009 Act”). See Virginia Code § 58.1-301 B 2 and VTB 09-1 (2/12/2009). By issuing bulletins, the Department was advising all Virginia taxpayers and practitioners that Virginia taxable income should be computed in accordance with IRC provisions to which Virginia did conform. For items to which Virginia does not conform, taxpayers and practitioners were put on notice that they must follow previous versions of the IRC.
Under the Taxpayer Relief Act of 1997 (the “1997 Act”), the United States Congress amended the general rules for NOL carry over periods. While the 1997 Act changed the amount of time NOLs could be carried back from three to two years, and the carry forward period from 15 to 20 years, it retained the three year carryback for certain losses.
Under IRC § 172(b)(1)(A), as in effect in 2008, a NOLD generally may be carried back two years and carried forward twenty years. In addition, under IRC § 172(b)(1)(F), the portion of an individual’s NOLD arising from casualty or theft could be carried back three years and carried forward twenty years. In accordance with the Virginia’s regulation, an individual’s NOLD arising from casualty or theft is permitted to be carried back for three taxable years. See Public Document (P.D.) 15-233 (12/16/2015). This ruling did not change the Department’s policy with regard to casualty losses. Instead it confirmed the Department’s interpretation of conformity to the IRC promulgated in Title 23 VAC 10-110-84, VTB 02-3 and VTB 09-1.
A review of the 2008 amended return indicates the Taxpayers may have incurred a loss from a trade or business as well as the casualty loss from the Ponzi scheme. While the casualty loss can be carried back three years, a loss from a trade or business can only be carried back two years. Under IRC § 172 prior to the enactment of the TCJA, the entire amount of an NOL for any taxable year was required to be carried to the earliest of the taxable years to which such NOL may be carried. In a situation under which an individual incurred a business loss from a partnership and a theft loss resulting from a Ponzi scheme in the same taxable year, the resulting NOL must be separated between the casualty loss, which can be carried back three years, and the business loss, which could only be carried back two years.
NOL Computation
Because the starting point in computing Virginia taxable income is FAGI, Virginia allows a NOLD to the extent that it is allowable in computing FAGI. See Title 23 VAC 10-110-84. Thus, before an individual may claim an NOLD, they must first determine if they have a NOL for Virginia income tax purposes. As explained in P.D. 18-115 (6/8/2018), the computation of an NOL has been complicated by exceptions to the IRC terminology and references enacted under Virginia Code § 58.1-301 B.
For a given taxable year, an individual may have an NOL if FAGI is a negative amount after subtracting the standard deduction or itemized deductions. To determine if an individual has an NOL and the amount of such NOL, the negative amount must be adjusted to eliminate any deduction for personal exemptions, capital losses in excess of capital gains, IRC § 1202 exclusions of the gains from the sale or exchange of qualified small business stock, nonbusiness deductions in excess of nonbusiness income, any NOLD carry over from another taxable year, and any domestic production activities deduction. See Internal Revenue Service (IRS) Publication 536 for more information concerning computing an NOL for federal income tax purposes.
Further, because Virginia does not fully conform to the IRC, the NOL must be further adjusted to determine if the individual has a federal NOL for Virginia income tax purposes. In 2003, Virginia began conforming to the IRC as of a specific or fixed date. Since then, the General Assembly has enacted legislation to move the fixed date forward each year. Effective for taxable years beginning on and after January 1, 2008, Virginia’s fixed-date of conformity was advanced from December 31, 2007, to December 31, 2008, with limited exceptions. See VTB 9-1. For the 2008 taxable year, Virginia disallowed federal deductions for bonus depreciation allowed for certain assets under IRC §§ 168(k), 168(l), 168(m), 1400L, and 1400N and the carry back periods enumerated above.
Fixed date conformity additions and subtractions are not considered to be Virginia modifications. Rather, these exceptions are added to or subtracted from FAGI as computed under the IRC in order to determine an individual taxpayer’s FAGI for Virginia income tax purposes. In order to compute the federal NOL allowed for Virginia income tax purposes, an individual would need to make either negative or positive adjustments for the bonus depreciation, the original issue discount on high yield discount obligations, the deferral of income from the discharge of indebtedness, and domestic production deduction conformity modifications related to items included in the computation of the NOL on the federal return. In addition, as with the computation of a federal NOL, any fixed date NOLD addition or subtraction carried over to the current taxable year would be excluded from the federal NOL (FNOL) computation for Virginia income tax purposes. An individual’s Virginia federal NOL (VAFNOL) would be calculated by starting with the FNOL as reported on the federal income tax return, adding applicable fixed date conformity additions (AFDCA) and the subtracting applicable fixed date conformity subtractions (AFDCS). The formula for determining Virginia FAGI would then be as follows:
FNOL + AFDCA - AFDCS = VAFNOL
For Virginia income tax purposes, an individual taxpayer will have an NOL only if the formula results in a VAFNOL that is less than zero. If AFDCA exceeds the total of a FNOL plus AFDCS, the individual taxpayer will not have a VAFNOL. Conversely, if AFDCS exceeds FNOL plus AFDCA, the taxpayer may have a VAFNOL for Virginia income tax purposes even if they do not report an NOL on their federal return.
As indicated above, the Taxpayers incurred two different types of losses in the same taxable year. When different carry back periods are required, a calculation is required in order to determine the eligible portion of the NOL for each carryback period. Lacking any guidance from the IRS, the Department will compute the eligible NOL based on the percentage of the total NOL. In the Taxpayers’ case, the casualty loss was divided by the sum of the casualty loss and the business loss and resulting percentage is applied to the total NOL to determine the portion eligible as a casualty loss. The remaining portion was treated as a business NOL, which could be carried back two years and forward 20.
Net Operating Loss Deduction
Generally, IRC § 172(b)(1)(A), as in effect in the taxable years at issue, permits NOLs to be carried back two years and carried forward 20 years from the year of loss. Taxpayers may, however, elect to forego the NOL carryback pursuant to IRC § 172(b)(3). The resulting NOLD, to the extent it exceeds taxable income for the taxable year to which it is carried, is carried forward to the next earliest taxable year in chronological order until it is completely absorbed.
While the federal NOL starts with FAGI of the loss year, IRC § 172(d) requires certain modifications to FAGI. For federal income tax purposes, deductions for state income tax, casualty and theft losses, and employee business expenses, with certain limitations are considered to be business expenses for purposes of computing an NOL. These deductions are also usually reported as itemized deductions on a federal income tax return.
These itemized deductions are not lost, however, for purposes of carrying over an NOLD. Virginia Code § 58.1-322.03 1 (formerly Virginia Code § 58.1-322 D 1 a) provides a deduction for federal itemized deductions less income tax imposed by Virginia or any other taxing jurisdiction and deducted on the federal return. These include both nonbusiness and business deductions. Because itemized deductions are permitted as a deduction separate from FAGI, they are treated as a modification in determining Virginia taxable income instead of an adjustment to the starting point for calculating Virginia income tax.
As indicated above, Virginia allows NOLDs to the extent that they are included in computing FAGI. Generally, an NOLD cannot exceed the amount of the FAGI for the taxable year to which it is carried. As such, the FAGI reported on a Virginia income tax return cannot be less than zero for a taxable year in which a taxpayer is claiming an NOLD. Further, because the computation is limited to amounts included in FAGI, itemized deductions included in the computation of the VAFNOL must be removed in order to report the correct portion of the VAFNOL in FAGI.
Virginia Modifications
Under Title 23 VAC 10-110-82, certain modifications must be made to any item that is a component of the federal NOLD. The net result of these modifications, which relates to the loss year, follows the federal NOL to the taxable year in which the loss is utilized. The Virginia NOLD modification applies in the same proportion as the amount of NOLD that is used. Title 23 VAC 10-110-83 contains examples of how to calculate the Virginia NOLD modification and includes model worksheets.
Positive modifications include the additions enumerated in Virginia Code § 58.1-322.01 (formerly Virginia Code § 58.1-322 B) and the negative modifications for subtractions in Virginia Code § 58.1-322.02 (formerly Virginia Code § 58.1-322 C). See Title 23 VAC 10-110-82. In addition, the modifications include the federal itemized deductions specified in Virginia Code § 58.1-322.03 1 a (formerly Virginia Code § 58.1-322 D 1 a). See Title 23 VAC 10-110-80.
The net amount of the Virginia NOLD modification to be applied to the carryback or carryforward year must be reported on the Virginia return corresponding to such carryback or carryforward year as a separate Virginia addition to, or subtraction from, FAGI, as the case may be. If the Virginia NOLD modification addition exceeds the amount of the NOLD, the modification addition would be reduced to equal the amount of the NOLD. The resulting effect of any carryover would result in no net change to the tax liability for the taxable year to which it is carried, but must be reported in order to correctly adjust the FAGI for that taxable year. Failure to report such a carryover could result in issues with subsequent federal adjustments or NOLDs from other taxable years.
It does not appear the Taxpayers accounted for all additions, subtractions, and nonbusiness itemized deductions reported for 2008 when they carried the casualty loss over to previous and subsequent taxable years. Likewise, the Department’s calculation of the Virginia NOL modification does not appear to have included itemized deductions.
Reporting an NOLD
In general, an NOLD for federal income tax purposes is limited to federal taxable income with certain modifications. Thus, the amount of the NOLD will almost never equal the FAGI for the taxable year to which the NOL is being carried.
Because Virginia requires a number of additional computations in determining the amount of an NOLD, an individual cannot simply apply the amount of a federal NOLD to the FAGI in a carryover year. Only after adjusting the federal NOLD to account for Virginia fixed date conformity additions and subtractions can an individual determine what portion of the NOLD may be used in the carryover year for Virginia income tax purposes.
As indicated above, an NOL can be carried back and forward in accordance with the rules established under IRC § 172, except for the five-year carryback allowed under IRC § 172(b)(1)(H). See Virginia Code § 58.1-301 B 2. Accordingly, a taxpayer must report the difference between the amount of the NOLD claimed on a federal income tax return and the amount usable for Virginia income tax purposes as a fixed date conformity subtraction. This amount would include fixed date additions and subtractions reported in the loss year.
In addition, because the Virginia NOLD modification must be applied with the NOLD, individuals must also report the applicable amount as an addition or subtraction. Although individuals generally report the Virginia NOLD modification on Virginia Schedule ADJ (Form 760-ADJ), any portion of the Virginia NOLD modification resulting from the difference between federal and Virginia carry over computations would properly be reported as a fixed date conformity addition or subtraction.
A separate schedule should be attached to the Virginia return to reconcile the amount of the VAFNOLD used to the amount of the VAFNOL carried over. In addition, taxpayers should attach a worksheet to the return showing the computation used to calculate the Virginia NOLD modification amount. The schedule should provide sufficient detail in order to show what amounts are reported as a reduction to FAGI as reported for federal income tax purposes, amounts reported as fixed date conformity adjustments, and the amount of the Virginia NOL modification.
Statute of Limitations
Pursuant to Virginia Code § 58.1-499 A, in the case of any overpayment of any tax, whether by reason of excessive withholding, overestimating and overpaying estimated tax, or error on the part of the taxpayer, the Department will order a refund of the overpayment. Virginia Code § 58.1-499 D specifies, however, in pertinent part that:
No refund under this section . . . shall be made . . . whether on discovery by the Department or on written application of the taxpayer, if such discovery is not made or such written application is not received within three years from the last day prescribed by law for the timely filing of the return . . . .
In addition, the general rule is that an amended return must be filed within three years of the original or extended due date, as applicable, to claim a refund. See Virginia Code § 58.1-1823. This code section includes a number of exceptions to the general rule when specific circumstances are present. Specifically, Virginia Code § 58.1-1823 A (ii) grants an individual one year from the date of a final determination or correction in federal tax liability to file an amended Virginia return. The Department’s records show that the Taxpayer’s federal tax liability was adjusted by the IRS on June 28, 2010. Under this provision, the Taxpayers had until June 28, 2011, to file an amended return. The Taxpayers did not file their amended 2005 Virginia return until July 1, 2016, well after the one year period.
The Taxpayers contend that the 2005 Virginia amended return should be accepted and a refund issued because the Department did not timely address the documentation provided by the Taxpayer and failed to provide guidance on the proper reporting of the loss. Virginia’s taxing system is based largely on the theory of self-assessment. Taxpayers are given the responsibility to compute, file and pay their own income tax. Virginia has implemented a self-assessment system based on the federal system because it is less intrusive upon the taxpayer, and less costly to the administration of the tax. Under this system, a taxpayer is responsible for consulting Virginia’s statutes, ruling letters, regulations, court decisions, the IRC, and other sources of tax jurisprudence in order to compute his Virginia tax liability correctly. See P.D. 13-149 (7/31/2013) and P.D. 15-253 (12/28/2015).
As explained above, the Department’s policy with regard to carrying back NOLs is longstanding. Thus, while the Department is willing to provide assistance to taxpayers, it is incumbent upon a taxpayer to file correct returns within the statute of limitations. The Taxpayers retained an accounting firm to calculate the NOLD carryback and timely file the proper Virginia amended returns. When a taxpayer relies on an accountant, lawyer, tax preparer or other tax professional and such professional provides inaccurate or erroneous advice, the taxpayer has recourse against the tax professional for the error.
CONCLUSION
Under Virginia’s conformity with the IRC, the Taxpayers were required to carry back the 2008 NOLD to the 2005 taxable year. Virginia statutes are clear and Virginia Code § 58.1-1823 does not provide the Department with any discretion in enforcing the limitations periods to file an amended return to claim a refund based on the circumstances presented in this case. Accordingly, the Department cannot grant your request for refund of the overpayment of individual income tax for the 2005 taxable year.
The Code of Virginia sections, regulation 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 Department’s Office of Tax Policy, Appeals and Rulings, at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1794.B