Tax Type
Individual Income Tax
Description
Interest expense to carry federal obligations
Topic
Subtractions and Exclusions
Taxable Income
Date Issued
05-22-1989
May 22, 1989
Re: Ruling Request
Individual Income Tax
Dear***************
This is in reply to your letter of January 5, 1988, in which you request that the department reconsider the ruling issued December 10, 1987 (copy attached) and to your letter of May 19, 1988, in which you provided additional information.
FACTS
Based upon the information provided in your letter dated April 30, 1987, the department determined on December 10, 1987 that the interest expense in question was not interest on indebtedness, but rather the payment of interest on obligations purchased between interest payment dates. However, based upon an examination of the information supplied by your clients' broker, it appears that the interest paid by your clients was in fact interest on indebtedness incurred to carry federal obligations, exempt from Virginia taxation.
RULING
Virginia Regulation (VR) 630-2-322 (C)(2) provides:
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- The subtraction for interest on exempt obligations must be reduced by any expenses attributable to such interest and by interest on indebtedness incurred or continued to purchase or carry exempt obligations pursuant to I.R.C. §265.
This regulation clearly provides that the subtraction under Virginia Code §58.1-322.C.1. must be reduced by any interest expense incurred to carry the exempt obligations. In making the determination of whether the Virginia subtraction should be reduced, the department follows the provisions of I.R.C. §265 and the guidelines set forth under Internal Revenue Procedure 72-18 (copy enclosed).
Absent this regulatory requirement, persons would be able to receive a double benefit if they borrow funds in order to purchase or to carry federal obligations exempt from Virginia taxation. They would be able to fully deduct the interest paid on the funds used to purchase or to carry such exempt federal obligations as an itemized deduction. (Prior to the federal Tax Reform Act of 1986.) Secondly, they would be able to deduct the interest income from the exempt federal obligation in the computation of Virginia taxable income.
You contend that the department's regulatory requirement to reduce the subtraction under Virginia Code §58.1-322.C.1. by any interest expense incurred to carry such exempt obligations violates the constitutional prohibition regarding state taxation of federal obligations. This constitutional prohibition regarding state taxation of federal obligations is codified under 31 U.S.C.A. §3124. This section provides in part:
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- (a) Stocks and obligations of the United States Government are exempt from taxation by a State or political subdivision of a State. The exemption applies to each form of taxation that would require the obligation, the interest on the obligation, or both, to be considered in computing a tax, except
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- (1) a nondiscriminatory franchise tax or another nonproperty tax instead of a franchise tax, imposed on a corporation; and
(2) an estate or inheritance tax.
- (1) a nondiscriminatory franchise tax or another nonproperty tax instead of a franchise tax, imposed on a corporation; and
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- (a) Stocks and obligations of the United States Government are exempt from taxation by a State or political subdivision of a State. The exemption applies to each form of taxation that would require the obligation, the interest on the obligation, or both, to be considered in computing a tax, except
Therefore, while we find that your clients' federal adjusted gross income and itemized deductions reported on their 1985 Virginia return were proper, the amount of subtraction claimed on line 30 should have been reduced by the amount of interest paid on indebtedness to carry the exempt federal obligations.
Accordingly, the assessment is proper.
Sincerely,
W. H. Forst
Tax Commissioner
Rulings of the Tax Commissioner