Tax Type
Individual Income Tax
Description
S corporation; out-of-state tax credit
Topic
Credits
Date Issued
05-27-1988
May 27, 1988
Re: Ruling Request
Individual Income Tax
Credit for Income Taxes Paid to Another State
Dear*********************
This is in reply to your letter of January 28, 1988, in which you request a ruling regarding the applicability of the Virginia out-of-state tax credit, under Virginia Code §58.1-332, to Virginia resident shareholders in an S corporation subject to the California Corporation Income Tax. In addition, you question the applicability of the credit to Virginia resident shareholders in an S corporation subject to the District of Columbia Corporate Franchise Tax.
FACTS
Prior to 1987, California law contained no provision similar to the federal provision covering S corporations. As part of the California Personal Income Tax Fairness, Simplification, and Conformity Act of 1987, the federal concept of the S corporation was adopted. Under the new California law, a corporation which has adopted S corporation status for federal income tax purposes, may elect to be taxed either as an S corporation or as a C corporation. If S corporation status is elected, the income, losses, deductions and credits of the S corporation are passed through to the shareholders in the same manner as for federal purposes; however, California also imposes a 2.5% tax on the net income of the corporation.
You question whether the taxation of S corporations by California will entitle Virginia resident shareholders of an Virginia S corporation, subject to the California Corporate Income Tax, to claim a credit on their Virginia income tax returns for income taxes paid to California by the S corporation.
RULING
Virginia Code §58.1-332 sets forth the requirements pertaining to when Virginia allows a resident of this state to claim a credit for income tax paid to another state. Subsection A provides:
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- Whenever a resident of the Commonwealth has become liable for income tax to another state, on earned or business income, or any part thereof, for the taxable year, derived from sources without the Commonwealth and subject to taxation under this chapter, the amount of income tax payable by him shall, upon proof of such payment, be credited on his return with the income tax so paid by him to such other state. The credit allowable under this section shall not exceed such proportion of the income tax otherwise payable by him under this chapter as his income upon which the tax imposed by such other state was computed bears to his Virginia taxable income upon which the tax imposed by this Commonwealth was computed. The credit provided for by this section shall not be granted to a resident individual when the laws of another state, under which the income in question is subject to tax assessment, provide a credit to such resident individual substantially similar to that granted by subsection B of this section. (Emphasis added.)
- Whenever a resident of the Commonwealth has become liable for income tax to another state, on earned or business income, or any part thereof, for the taxable year, derived from sources without the Commonwealth and subject to taxation under this chapter, the amount of income tax payable by him shall, upon proof of such payment, be credited on his return with the income tax so paid by him to such other state. The credit allowable under this section shall not exceed such proportion of the income tax otherwise payable by him under this chapter as his income upon which the tax imposed by such other state was computed bears to his Virginia taxable income upon which the tax imposed by this Commonwealth was computed. The credit provided for by this section shall not be granted to a resident individual when the laws of another state, under which the income in question is subject to tax assessment, provide a credit to such resident individual substantially similar to that granted by subsection B of this section. (Emphasis added.)
This same section was amended effective for taxable years beginning on and after January 1, 1985 to allow individual shareholders in an S corporation to claim a credit on their Virginia individual income tax return for income taxes paid by the S corporation to another state. This section provides in part that, "... the amount of any state income tax paid by an electing small business corporation (S corporation) shall be deemed to have been paid by its individual shareholders in proportion to their ownership of the stock of such corporation."
California law generally allows a Virginia resident to claim a credit against his California tax for Virginia tax resulting from his share of ownership in the S corporation. However, the tax upon which the credit is allowed is restricted to the tax arising from income, losses and deductions of the S corporation attributable to California that are passed through to the shareholder in the same manner as for federal purposes. California law has no provision similar to Virginia Code §58.1-332. C., which deems the 2.5% tax to have been paid by the individual shareholders in proportion to their ownership of the stock of the corporation.
Therefore, since California does not allow a Virginia resident a credit against the 2.5% tax that is imposed upon the S corporation, a Virginia resident may claim a credit on his Virginia resident return for his prorata share of the California tax imposed upon the S corporation. This credit is only applicable to the 2.5% California tax imposed on S corporations which make the election to be taxed as an S corporation or the California corporate income tax that is imposed on S corporations which elect to be taxed as C corporations.
No credit is allowable on the Virginia return for the California tax that is imposed on the individual shareholder of the S corporation resulting from his share of ownership in the S corporation.
You also requested a ruling regarding the applicability of the credit to Virginia resident shareholders in an S corporation subject to the District of Columbia Corporate Franchise Tax.
The department ruled on this question on May 10, 1988. A copy of that ruling is enclosed. As you can see from the enclosed ruling, because the tax imposed on the S corporation by the District of Columbia is not a "state income tax", the tax paid to the District may not be claimed as a credit against the Virginia income tax liability.
If you have any further questions, please do not hesitate to contact the department.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner