Could a Virginia resident claim all dependent exemptions when filing separately from a nonresident military spouse?

Subject

Servicemembers Civil Relief Act

Plain-English summary

A Virginia resident could claim the couple's dependent exemptions by mutual agreement when filing separately from her nonresident military spouse. The couple filed joint federal returns for 2006 and 2007. The wife filed separate Virginia returns, while the servicemember filed none because he had no Virginia-source income.

The Department initially allocated both dependent exemptions and itemized deductions in proportion to the spouses' joint income. Virginia law treated those categories differently.

For dependent exemptions, married taxpayers filing separately could allocate the federal exemptions as they mutually agreed. Proportional allocation applied only when the couple could not separately account for the exemptions. Because this couple agreed that the wife would claim the dependents, Virginia restored them to her returns.

Itemized deductions required proof of who paid each expense. A spouse could claim a deduction traced to that spouse's separate funds; inadequate records required allocation in proportion to income. The ruling discussed the Servicemembers Civil Relief Act's prohibition against using a nonresident servicemember's military compensation to increase tax on other income, but the relief expressly ordered was restoration of the dependent exemptions.

Because the assessments had already been paid, that adjustment produced refunds for both years.

What this means for you

• Dependent exemptions and itemized deductions do not use the same allocation rule.
• A resident and nonresident spouse may mutually allocate dependent exemptions on separate Virginia returns.
• Receipts and payment records are necessary to allocate itemized deductions to one spouse rather than proportionally.
• A nonresident servicemember's protected military pay cannot be taxed indirectly by increasing tax on other income.

Common questions

Did both spouses need Virginia taxable income to allocate dependents by agreement?

No. The ruling said Va. Code § 58.1-324 did not impose that condition.

Were all itemized deductions automatically restored to the Virginia spouse?

No. Itemized deductions required separate payment tracing or proportional allocation when records were inadequate.

What relief did the ruling grant?

It restored the dependent exemptions and ordered refunds for 2006 and 2007.

Citations and references

• Va. Code §§ 58.1-324(C)(5) and 58.1-326.
• 23 VAC 10-110-190(A) and (B).
• 50 U.S.C. § 571(d), Servicemembers Civil Relief Act.
• IRS Revenue Ruling 71-268.
• Virginia Public Documents 03-20 and 95-251.
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Law No. 82-0846 (Roanoke City Cir. Ct. Oct. 27, 1983).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-199

Original ruling text

August 31, 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 assessments issued to * (the "Taxpayer") for the taxable years ended December 31, 2006 and 2007.

FACTS

The Taxpayer, a resident of Virginia, was married to a nonresident member of the armed forces. For the 2006 and 2007 taxable years, the couple filed joint federal income tax returns, and the Taxpayer filed separate Virginia income tax returns. The Taxpayer's spouse, a military serviceman, did not file Virginia returns 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 Taxpayer's Virginia income tax returns. The itemized deductions and dependent exemptions claimed were adjusted proportionally according to the couple's joint income. As a result, the Department issued assessments for additional tax and interest for the taxable years at issue. The assessments were upheld because the Taxpayer did not provide documentation showing that the itemized deductions at issue were paid out of her separate income.

The Taxpayer appeals the assessments, contending that Virginia law permits married taxpayers filing separate returns to allocate dependent exemptions as mutually agreed. Further, the Taxpayer contends 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

The Taxpayer asserts that Title 23 of the Virginia Administrative Code (VAC) 10­110-190 only applies to a Virginia nonresident filing separately from her spouse, rather than to a resident. Further, the Taxpayer asserts that the decision to allocate all the dependent exemptions to the wife's separate return was mutually agreed in accordance with Va. Code § 58.1-324.

In explaining Va. Code § 58.1-326, Title 23 of VAC 10-110-190 clearly applies in cases where "one spouse is a resident of Virginia and the other is a nonresident." See Title 23 VAC 10-110-190 A. In this case, the Taxpayer is a resident while the spouse is not.

If a joint federal income tax return is filed and each spouse is a domiciliary or actual resident of a different state, the couple is not required to file a joint Virginia individual income tax return. Instead, each spouse with income subject to Virginia income taxation may file a separate Virginia return. In such circumstances, Title 23 VAC 10-110-190 B provides that personal exemptions must be accounted for separately by each spouse. If the couple is unable to separately account for these exemptions, they must be allocated proportionately between each spouse based on income attributable to each.

It should be pointed out that allocating exemptions proportionately is only done when a married couple is unable to separately account for dependent exemptions. When such is the case, Public Document (P.D.) 03-20 (3/20/2003) prescribes the appropriate method for determining how many dependent exemptions would be attributed to each spouse.

When married taxpayers file a joint federal income tax return, but file separately for Virginia, Va. Code § 58.1-324 C 5 provides:

Personal exemptions properly allowable for federal income tax purposes shall be allocated for Virginia income tax purposes as husband and wife may mutually agree; however, exemptions for taxpayer and spouse together with exemptions for old age and blindness must be allocated respectively to the spouse to whom they relate.

Virginia Code § 58.1-324 does not specify that both spouses must have Virginia taxable income in order to allocate personal exemptions as the husband and wife mutually agree. In this case, the Taxpayer and the spouse mutually agreed to allow the Taxpayer to claim the dependent exemptions on her 2006 and 2007 income tax returns. Because they were able to separately account for their dependent exemptions, proportional allocation under Title 23 VAC 10-110-190 B was not required.

In the case of personal exemptions, Title 23 VAC 10-110-190 B and P.D. 03-20 provide for dividing the exemptions proportionately only in cases where a married couple is unable to separately account for such exemptions.

Servicemembers Civil Relief Act

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, 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 23 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).

CONCLUSION

Based on the foregoing, the Taxpayer's 2006 and 2007 Virginia income tax returns will be returned to the auditor so that the Taxpayer's allocation of dependent exemptions may be restored. Because the assessments have been paid, these adjustments will result in a refund for each taxable year.

The Code of Virginia and regulation sections, and the public document 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,

Craig M. Burns

Acting Tax Commissioner

AR/1-4326982869.E