Tax Type
Individual Income Tax
Description
Taxes paid by residents to other states; Lottery winnings
Topic
Credits
Date Issued
06-12-1995
June 12, 1995
Re: §58.1-1821 Application: Individual Income Tax
Dear***************
This will reply to your letter of March 20, 1995, in which you and your spouse (the "Taxpayers") protest the disallowance of an out-of-state tax credit claimed on your Virginia return for taxable year 1992.
FACTS
The Taxpayers are Virginia residents who won the Maryland lottery several years ago and have received yearly payments since that time. The Taxpayers are required by Maryland law to file annual tax returns and pay income tax as nonresidents on their gambling winnings.
For years prior to 1992, a Maryland nonresident could claim a credit against his Maryland tax liability for taxes paid to his state of residence, but only if his state of residence afforded Maryland residents the same treatment. Because Virginia has such a statute, the Taxpayers were able to claim a credit against their Maryland nonresident tax liability for the income tax paid to Virginia on the gambling winnings. Maryland changed its laws and repealed this credit for nonresidents, effective for taxable years beginning after December 31, 1991.
When the Taxpayers filed their 1992 Virginia return, they claimed a credit for income taxes paid to Maryland on their gambling winnings because they were no longer able to claim this credit on their Maryland nonresident return. The Taxpayers' Virginia return was subject to an office audit by the department and the credit was disallowed, resulting in an assessment. The Taxpayers believe the assessment is incorrect and hereby request relief.
DETERMINATION
Code of Virginia §58.1-332(A) provides that "[w]henever a Virginia resident has become liable to another state for income tax on any earned or business income...derived from sources outside the Commonwealth and subject to taxation under this chapter, the amount of such tax payable by him shall...be credited on the taxpayer's return with the income tax so paid to the other state."
The above statute does not provide a credit for all tax paid to another state, rather it limits the credit to tax paid to "earned or business income" from sources outside of Virginia. While the statute itself does not define "earned or business income," Virginia Regulation (VR) §630-2-332 does define these terms for the purposes of the credit.
VR §630-2-332 defines "earned income" as;
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- ...wages, salaries, or professional fees and other amounts received as compensation for professional services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. Earned income does not include interest or dividend income, capital gains, income from investments, or similar types of passive income.
The regulation defines "business income" as;
...income derived from an activity which constitutes a "business" for federal income tax purposes for which a federal Schedule C, E, or F must be filed, for example, a sole proprietorship, provided that if the business incurred a loss such loss would be allowable under federal law. Thus income from hobbies and other activities not engaged in primarily for profit is not business income even though a Schedule C, E, or F may be filed for such activities.
- ...wages, salaries, or professional fees and other amounts received as compensation for professional services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. Earned income does not include interest or dividend income, capital gains, income from investments, or similar types of passive income.
In this case, the gambling income received by the Taxpayers resulted from placing a small wager (i.e. purchasing a ticket from a state sponsored lottery) and winning a substantial prize payable over a series of years. The payor of the prize, as is customary, purchased an annuity in order to satisfy the obligation to the Taxpayers. The Taxpayers report this income as "other income" on their federal income tax return.
Due to the specific nature of Code of Virginia §58.1 -322(A) and the corresponding regulation, the department is unable to find that the gambling winnings received by the Taxpayers fall within the definition of earned or business income. These winnings clearly do not compensate the Taxpayers for services rendered, the requirement for income to fall within the definition of earned income.
Additionally, the gambling winnings received by the Taxpayers do not constitute income derived from a trade or business. There is long-standing federal policy that requires gambling activities to be pursued full-time, regularly, and for production of income for one's livelihood before such activities can be considered to be a trade or business. In addition, the collection of sweepstakes winnings have been held not to constitute a trade or business for federal income tax purposes. See Max Silver. Petitioner. V. Commissioner of Internal Revenue. Respondent, (1940) 42 BTA 461.
A Virginia resident deriving income from sources outside of Virginia will be exposed to the risk of such income being subject to double taxation because Code of Virginia §58.1 -332(A) restricts the credit to earned or business income. As a consequence of the change in Maryland law, the Taxpayers are now required to pay tax to both states on their gambling winnings. However, it is well established that the taxing of income by more than one state is not illegal or unconstitutional. The U.S. Supreme Court held the Due Process Clause does not prevent the multiple taxation of personal income by more than one state. See Curry v. McCanless, (1939) 307 U.S. 357 and Graves v. Elliott, (1939) 307 U.S. 383.
Although I am sympathetic to your situation, the department has no authority under the current law but to deny your request for relief. Attached is a schedule indicating the tax liability plus interest accrued through the date of this letter. The assessment should be paid in full within 30 days to avoid the accrual of additional interest. Please forward your payment to the Office of Tax Policy, the Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23282. Should you have additional questions regarding this matter, please contact****************.
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- Sincerely,
Danny M. Payne
Tax Commissioner
- Sincerely,
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Rulings of the Tax Commissioner