95-96 | Virginia Tax

Tax Type

Individual Income Tax

Description

Taxes paid by residents to other states; New York source income

Topic

Credits

Date Issued

05-01-1995

May 1, 1995

Re: §58.1-1821 Application: Individual Income Tax

Dear ****

This will reply to your letter of May 2 1994 in which you (the "Taxpayer") protests the reduction of a credit for income tax paid to another state claimed on your Virginia return for taxable year 1991.

FACTS

During 1991 the Taxpayer had income from New York sources. The Taxpayer filed a New York nonresident return and paid income tax to that state. Because the Taxpayer's New York source income was of the type that qualifies for a credit against Virginia income tax liability under Code of Virginia 58.1-332(A) the Taxpayer computed and claimed this credit for 1991.

The Taxpayer's return was subject to an office audit and the credit for New York taxes paid was adjusted resulting in an assessment. The department recomputed the Taxpayer's credit in accordance with the method described in Public Document ("P.D.") 94-91 (3/29/94) copy attached. In P.D. 94-91 the department ruled on the proper method by which a Virginia resident computes a credit for taxes paid to New York.

You aver the method described in P.D. 94-91 is incorrect and contrary to Virginia law; therefore the assessment should be abated in full.

DETERMINATION

Effective for 1988, New York enacted legislation changing the method by which the income of nonresident individuals would be taxed. The new law changed New York's tax formula for nonresidents, requiring the nonresident to first compute both New York taxable income and income tax as if the nonresident were in fact a resident. The tax computed as if a resident is converted to a "nonresident tax" by applying a fraction, the numerator of which is the gross income from New York sources, and the denominator of which is the gross income from all sources.

Code of Virginia §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. However, Code of Virginia §58.1-332(A), in pertinent part, places a limitation on the credit:

- 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 the other state was computed bears to his Virginia taxable income upon which the tax imposed by this Commonwealth was computed ... (Emphasis added).

Therefore, 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 will be limited to the lessor of: (i) the amount of tax actually paid to the other state (the "tentative credit"); or (ii) the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state (the "limitation"). The limitation is computed by multiplying the individual's Virginia tax liability by a fraction, the numerator of which is the income upon which the other state's tax is imposed, and the denominator of which is Virginia taxable income.

Virginia law prevents double taxation, but does not necessarily indemnify a taxpayer for the entire amount of tax paid to another state. A resident incurring a tax liability to another state which imposes a tax burden that is greater than Virginia's will be credited, in most instances, only to the extent of the Virginia tax on such income.

At issue here is what constitutes the amount of income on which the New York nonresident tax is based for the purposes of computing the limitation imposed by Code of Virginia §58.1-332(A). You believe the department's ruling in P.D. 94-91 misinterprets the intent of Virginia law. You contend the New York nonresident tax is based upon your entire income. Consequently, you maintain the New York taxable income calculated as a resident is the amount on which your New York tax is actually based, and therefore is the correct amount to be used in the numerator of the fraction to compute the limitation.

An analysis of the New York nonresident tax structure is required in order to fully understand the problem presented by your argument. New York has aggressive, graduated income tax rates which greatly exceed those imposed by Virginia. New York requires a nonresident to compute his tax as if he were a resident, and then prorates the tax. Virginia, on the other hand, prorates taxable income, and then taxes the prorated sum. The difference is that New York's calculation results in a tax determined at high incremental rates (i.e. the larger income figure pushes into higher rate brackets) which is then prorated.

The method employed by New York would result in a higher tax than Virginia even if Virginia and New York employed the same rate schedule. Although New York calculates its tax on income determined as if a resident, the tax is then prorated. New York is not actually taxing a nonresident's entire income, which in fact would be unconstitutional. New York's method utilizes taxable income as if a resident merely to determine the incremental tax bracket at which the income shall be taxed. The proration of the tax based on the amount of income from New York sources as a percentage of total income clearly contemplates taxation of income attributable to New York sources.

In Brady v. State of New York, 80 N.Y.2d 596 (1992), cert. denied, 113 S.Ct. 2998 (1993), the New York Court of Appeals examined constitutional issues raised by several individuals subject to the New York nonresident tax. The taxpayers in Brady maintained, like yourself, that New York's method was taxing nonresidents on income attributable to sources outside of the state. The court found that unlike residents, the tax imposed on nonresidents was reduced proportionately based on non-New York source income, and therefore did not tax income from sources outside of New York. The state's consideration of the taxpayer's total income in determining the rate of tax paid measured the taxpayer's ability to pay and was unquestionably constitutional. In light of the decision in Brady, the department cannot agree that New York taxes the entire income of a nonresident.

Furthermore, the department finds that New York's consideration of a nonresident's income from all sources in its tax calculation has no relevance in computing the credit limitation imposed by Code of Virginia §58.1-332(A). The Virginia credit limitation clearly contemplates a net taxable income on which the other state imposes its tax. As previously stated, the nonresident's total income is used for New York purposes to determine the marginal tax rates that are applicable to the nonresident's New York income. The Virginia limitation determines the amount of Virginia income tax imposed on the income taxed in New York. The distinction is that the Virginia limitation focuses on the income actually taxed by New York, not at what rate New York taxes the income. Thus, New York's use of income from all sources to computed nonresident tax liability will only be relevant for the purposes of determining the tentative Virginia credit.

Because of New York's two-part method of computing the tax liability of a nonresident, it is not possible to identify one particular entry on the New York nonresident tax return which represents the income subject to tax in New York. In recognition of this, the department issued P.D. 94-91 to instruct taxpayers as to the method for computing a Virginia credit for income tax paid to New York.

For the purposes of calculating the Virginia credit, P.D. 94-91 provides a calculation to determine the amount of income on which the New York nonresident tax is based. This ruling requires that the allocation percentage calculated on the New York nonresident return, (which is used to convert the resident tax to the nonresident tax), must be applied to the New York taxable income calculated as a resident in order to determine the New York nonresident taxable income. The result is used in the numerator of the fraction to compute the limitation imposed by Code of Virginia §58.1-332(A). The department believes this method gives proper regard to the gross income from New York sources, as well as the amount of deductions and exemptions allowable by New York in its tax computation.

By comparison, your method would result in a credit equal to 100% of the tax paid to New York in almost every instance, which would clearly distort the intention of the limitation imposed by Code of Virginia §58.1-332(A). Therefore, the department believes the method described in P.D. 94-91 conforms to the intent of the limitation language of Code of Virginia §58.1- 332(A) by determining the proper amount on which the New York nonresident tax is actually imposed.

Accordingly, your application for relief must be denied. A review of your account shows your 1991 assessment was previously paid in full. Should you have additional questions regarding this matter, please contact ****.

- - - - Sincerely,
        
        Danny M. Payne
        Tax Commissioner

OTP/8066L

Rulings of the Tax Commissioner