Rulings of the Tax Commissioner

May 26, 2022

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 “Taxpayer”) for the taxable year ended December 31, 2017.  I apologize for the delay in responding to your request.

FACTS

The Taxpayer was a nonresident of Virginia who had an ownership interest in an S corporation (VASC) that had Virginia taxable income during the 2017 taxable year.  He filed his 2017 Virginia nonresident individual income tax return claiming a subtraction for deferred foreign income earned by the VASC. Under review, the Department disallowed the subtraction and issued an assessment. The Taxpayer appeals, contending that he was entitled to claim the subtraction as subpart F income.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenue Code (IRC) unless a different meaning is clearly required. For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Virginia Code §§ 58.1-322.01 through 58.1-322.04.  

Pursuant to Virginia Code § 58.1-402 C 7, corporations are allowed to subtract “[A]ny amount included therein by the operation of § 951 of the Internal Revenue Code (subpart F income).” The Taxpayer contends that VASC had subpart F income that flowed to him in proportion to his ownership interest. As such, he asserts that he could claim a subtraction on his personal income tax return for the subpart F income.  

For the 2017 taxable year, the Tax Cuts and Jobs Act (TCJA) requires domestic parent corporations or United States individual shareholders to pay a one-time income tax at reduced rates on all their untaxed foreign profits earned in prior years. This is referred to as “repatriation.” The repatriation amount consists of the gross inclusion of post-1986 accumulated, untaxed earnings and profits under IRC § 965, which is prescribed as additional subpart F income, and the deduction under IRC § 965(c). The difference between VASC’s untaxed earnings and profits and its IRC § 965(c) deduction was reported by the Taxpayer in his FAGI for the 2017 taxable year. He then claimed a subtraction of this amount as subpart F income.

Virginia Code § 58.1-401 exempts “electing small business corporations” from Virginia corporation income tax. As a result, S corporations are not subject to tax in Virginia. Instead, the income of such corporations is taxed to the shareholders. All pass-through entities, including S corporations, are required to file an annual information return with the Department setting forth their income and a list of their owners. Specifically, Virginia Code § 58.1-391 A provides:

In determining Virginia taxable income of an owner, any modification described in § 58.1-322.01, § 58.1-322.02, § 58.1-322.03 and § 58.1-322.04 that relates to an item of pass-through entity income, gain, loss or deduction shall be made in accordance with the owner’s distributive share, for federal income tax purposes, of the item to which the modification relates.

Under these statutes, any subtraction available under Virginia Code § 58.1-322.02 will flow through from a pass-through entity to an individual taxpayer, who in turn can take the subtraction on his or her Virginia individual income tax return. The statute, however, limits the type of subtraction modifications passed through from pass-through entities to those permitted under Virginia Code § 58.1-322.02. See Public Document (P.D.) 10-274 (12/6/2010) and P.D. 18-76 (5/2/2018).  

Virginia Code § 58.1-322.02 does not provide a subtraction for subpart F income.  Because the subpart F income was included in the Taxpayer’s FAGI and the Code of Virginia does not permit a subtraction for such income, the Department was correct in disallowing the subtraction on the 2017 income tax return. Accordingly, the 2017 assessment is upheld.

An updated bill will be issued shortly. The Taxpayer should remit payment of the balance due within 30 days of the bill date to avoid the accrual of additional interest and possible collections actions.

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/2001.B