Could Virginia proportionally allocate deductions and a dependent exemption between a resident spouse and a nonresident servicemember?

Subject

Servicemembers Civil Relief Act

Plain-English summary

Virginia had to restore a dependent exemption that a resident spouse and her nonresident servicemember husband had mutually assigned to her, but it correctly allocated their untraced itemized deductions in proportion to income. The couple filed a joint federal return, while the Virginia resident filed separately in Virginia and the servicemember filed no Virginia return because he had no Virginia-source income.

Dependent exemptions should be separately accounted for when possible. Because the spouses agreed that the resident spouse would claim the child, proportional allocation of that exemption was not required.

Itemized deductions were different. A deduction could be assigned to the spouse who showed that it was paid from that spouse's funds. When records were inadequate, Virginia's regulation required proportional allocation based on income. The Department found that method fair and upheld its itemized-deduction adjustment.

The ruling rejected the argument that using the nonresident spouse's military compensation in the allocation violated the Servicemembers Civil Relief Act. Virginia returned the 2006 assessment to the auditor to restore the dependent exemption and issue an updated bill.

What this means for you

• Resident and nonresident spouses filing separately should trace deductions and exemptions to the proper spouse when possible.
• A mutually assigned dependent exemption can be separately accounted for without proportional allocation.
• Untraced itemized deductions may be divided according to each spouse's share of income.
• An order to adjust an assessment does not necessarily mean that a refund will result.

Common questions

Why was the dependent exemption restored?

The spouses had agreed that the resident spouse would claim the child, so the exemption had been separately accounted for.

Why were the itemized deductions still allocated proportionally?

The records did not show which spouse paid them from separate funds, triggering Virginia's proportional-allocation rule.

Did the ruling order a refund?

No. It returned the assessment to the auditor for adjustment and said an updated bill notice would follow.

Citations and references

• Va. Code §§ 58.1-322(D), 58.1-324(C)(5), and 58.1-326.
• 23 VAC 10-110-190(B).
• Servicemembers Civil Relief Act, 50 U.S.C. § 571(d), as cited in the ruling.
• Virginia Public Documents 95-251, 99-82, and 03-20.
• Virginia Tax Bulletins 09-10 and 10-1.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-171

Original ruling text

August 10, 2010

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, 2006.

FACTS

The Taxpayer, a resident of Virginia, was married to a nonresident member of the armed forces. For the 2006 taxable year, the couple filed joint federal income tax returns, and the Taxpayer filed a separate Virginia income tax return. The spouse, a military serviceman, did not file a Virginia return because he had no income from Virginia sources.

The Department reviewed the allocation of the couple's itemized deductions and dependent exemptions between the Taxpayer and the spouse as reported on the Virginia return. As a result of this review, the itemized deductions and dependent exemptions claimed were adjusted proportionally according to the couple's joint income and an assessment was issued.

The Taxpayer appeals the assessment, contending that the adjustments increased the Taxpayer's Virginia income tax liability in violation of the Servicemembers Civil Relief Act.

DETERMINATION

Virginia Code § 58.1-326 states, "if husband or wife is a resident and the other is a nonresident, separate taxes shall be determined on their separate Virginia taxable incomes on such single or separate forms as may be required by the Department, unless both elect to determine their joint Virginia taxable income as if both were residents." (Emphasis added.)

Dependent Exemptions

Virginia Code § 58.1-322(D) permits Virginia residents to deduct $900 from federal adjusted gross income (FAGI) for each personal exemption allowed on their federal income tax returns.

In a case where a joint federal income tax return was filed and each spouse is a domiciliary or actual resident of a different state, the couple will not file a joint or combined Virginia individual income tax return. Therefore, income tax deductions and personal exemptions must be accounted for separately by each spouse. Title 23 of the Virginia Administrative Code (VAC) 10-110-190(B), provides that if the couple is unable to separately account for these deductions and exemptions, they must be allocated proportionally between each spouse based on income attributable to each.

Whenever possible, the determination of which spouse may claim a child as a dependent on a separate Virginia individual income tax return should be determined in accordance with the dependency tests developed by the Internal Revenue Service (IRS) for this purpose. In addition, proportional allocation only applies to dependent exemptions. Further, Va. Code § 58.1-324(C)(5) specifies that personal exemptions for the taxpayer and spouse or any additional exemption allowed on account of age or blindness must be allocated to the spouse to whom they relate. See also Public Document (P.D.) 99-82 (4/21/1999) and P.D. 03-20 (3/20/2003).

In P.D. 99-82, the Department concluded that an exemption for a child has been accounted for separately when such child is claimed on one of the spouse's income tax returns. In this case, the Taxpayer and the spouse mutually agreed to allow the Taxpayer to claim the dependent exemption on her 2006 income tax return. Because they were able to separately account for their dependent exemptions, allocation under Title 23 VAC 10-­110-190 B was not required.

Itemized Deductions

The Taxpayer asserts that the Department lacked authority to adjust the itemized deductions and personal exemptions because the spouse's military pay was used to proportionally adjust the deductions. Under the Servicemembers Civil Relief Act (50 U.S.C. § 571), a state may not tax the income of a member of the armed services who maintains his or her domicile in another state. Specifically, 50 U.S.C. § 571 (d) states:

A tax jurisdiction may not use the military compensation of a nonresident service member to increase the tax liability imposed on other income earned by the nonresident service member or spouse subject to tax by the jurisdiction.

According to the Taxpayer, the Department's policy, as it is applied in this case, is tantamount to an increase in Virginia taxability based on a nonresident individual's military pay.

By reason of their character as legislative grants, however, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell's Motor Freight, Inc., et al. v. Virginia Department of Taxation , Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).

Consistent with Internal Revenue Service Revenue Ruling (Rev. Rul.) 71-268, an itemized deduction is allowable under Title VAC 10-110-190 to the spouse who can account for the payment by demonstrating the payment was made out of his or her funds. However, if records are inadequate to facilitate such an accounting, the regulation requires an allocation of itemized deductions in proportion to income. The Department finds a proportionate determination to be fair, rational and equitable in the absence of separate accounting. See P.D. 95-251 (9/29/1995). Accordingly, the Department's adjustment to the itemized deductions is correct.

CONCLUSION

In accordance with this determination, the 2006 assessment will be returned to the auditor to be adjusted. Upon completion, an updated bill notice will be issued to the Taxpayer.

Please note that the Service Members Civil Relief Act was amended, effective for taxable year 2009 and thereafter, to provide that a spouse can neither lose nor acquire domicile or residence in a state when the spouse is present in the state solely to be with the service member in compliance with the service member's military orders if the residence or domicile is the same for both the service member and spouse. See Tax Bulletin (VTB) 9-10 (11/12/2009) and VTB 10-1 (1/29/2010) for more information on this change.

The Code of Virginia sections, regulation, tax bulletins and public documents cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department of Taxation's web site. If you have any questions about this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Linda Foster

Deputy Tax Commissioner

AR/1-4202299818.E