September 7, 2021
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will respond to your letter in which you seek a refund of individual income tax paid by ***** (the “Taxpayer”) for the taxable year ended December 31, 2017.
FACTS
The Taxpayer was a domiciliary resident of Virginia and an actual resident of Maryland during the 2017 taxable year. He filed both Virginia and Maryland resident income tax returns for the 2017 taxable year. On his 2017 Virginia resident income tax return, the Taxpayer claimed an out-of-state tax credit for payment of both the Maryland state income tax and the local county income tax. Under review, the Department disallowed the portion of the credit claimed for local income tax paid. It then issued an assessment. The Taxpayer paid the assessment and appealed, contending he was eligible to claim the credit for the local income tax because the denial of the credit would result in double taxation in violation of the Commerce Clause of the United States Constitution.
DETERMINATION
Classification of Tax
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. 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 credit is also subject to the further limitation that the income upon which the credit may be claimed must be “derived from sources outside the Commonwealth” and otherwise subject to Virginia income tax. See Virginia Code § 58.1-332 A. Further, pursuant to Title 23 of the Virginia Administrative Code (VAC) 10-110-220 A, the credit is inapplicable to taxes imposed by any city, county, regional or other local taxing jurisdiction regardless of the fact that such local tax may be collected by a state.
Commerce Clause
The Taxpayer contends that if he is not permitted to claim a credit for the local income tax paid, such income is subject to double taxation in violation of Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787, 191 L. Ed. 2d 813 (2015).
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.” Most recently, in Wynne, the United States 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 United States 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 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 United States Supreme Court first adopted the “internal consistency test in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977). 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 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).
The Taxpayer cites an example explained by the Court in Wynne in support of his position that Virginia’s failure to grant a credit for local income tax paid to another state violates the internal consistency test. The Court imagined that every state imposed the following taxes, which were similar to Maryland’s “county” and “special nonresident” taxes: 1) a 1.25% tax on income that residents earn in State, 2) a 1.25% tax that residents earn in other jurisdictions and 3) a 1.25% tax on income that nonresidents earn in State. The Court assumed that two taxpayers, April and Bob, both lived in State A, but April earned her income entirely in State A and Bob earned his income in State B. In this hypothetical scenario, April would only be liable for the 1.25% tax on income she earned in State A, whereas Bob would be liable for 1.25% tax to State A on income he earned in State B as well as a 1.25% tax to State B for income he earned as a nonresident there. In arguing that the facts of his case are analogous to this example, the Taxpayer substitutes Virginia for State A and Maryland for State B. He argues that like Bob, he will pay tax twice, once to Maryland where he earned the income and once to Virginia, the state where he resided.
This example, however, was used to illustrate the internal consistency result as if all states imposed Maryland’s county and special nonresident taxes. Virginia does not have a local income tax or its special nonresident tax equivalent. Virginia merely imposes state tax on all of the income of its residents and income earned in the state by nonresidents. For purposes of testing the internal consistency of Virginia’s tax scheme, only Virginia’s scheme is relevant. Because Virginia only imposes a state income tax on its residents, as long as Virginia offers its residents a credit for state income taxes paid to other states, internal consistency is assured. The fact that Maryland in this Taxpayer’s case imposed a local income tax in addition to its state income tax created an interaction between two different taxing schemes that did not impact the internal consistency of Virginia’s tax scheme. Therefore, this case falls under the second category of taxes described above which the Court deemed constitutional in Wynne.
CONCLUSION
Contrary to the assertions by the Taxpayer, the denial of the credit in this case does not violate the Commerce Clause of the United States Constitution nor is it contrary to the Supreme Court’s decision in Wynne. Accordingly, the Taxpayer’s request for a refund cannot be granted.
The Code of Virginia sections, regulation and public document 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/3684.B