Could Virginia residents subtract a 2008 gain from foreign real property because the foreign country taxed it and federal law allowed a foreign tax credit?

Plain-English summary

Virginia taxed the foreign property gain because it was included in the residents' federal adjusted gross income and no state subtraction applied. Virginia generally starts its individual income-tax calculation with federal adjusted gross income.

Virginia once allowed a subtraction for certain foreign-source income, but the General Assembly repealed it for taxable years beginning on and after January 1, 2003. The couple's 2008 gain therefore remained in the Virginia tax base.

The foreign tax credit claimed on the federal return did not create a Virginia subtraction or credit. The couple did not provide a treaty provision requiring Virginia relief, and the ruling said federal treaty treatment could not override the General Assembly's repeal of the state subtraction. It also relied on authority recognizing that taxation of the same income by more than one jurisdiction is not by itself unconstitutional.

Common questions

Q: Did paying income tax to the foreign country create a Virginia credit?
A: No. The ruling identified no Virginia provision allowing the requested relief.

Q: Did the federal foreign tax credit remove the gain from Virginia income?
A: No. The gain remained in federal adjusted gross income, Virginia's starting point.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322.
• Virginia Public Documents 03-54 (May 3, 2003), 07-1 (February 22, 2007), 08-103 (June 18, 2008), and 09-50 (April 27, 2009).
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Law No. 82-0846 (Roanoke Cir. Ct. October 27, 1983).
• Guaranty Trust Co. of New York v. Virginia, 305 U.S. 19 (1938).

Subject

Gain sale in Country A was included in the Taxpayers' FAGI: No subtraction allowed

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-124

Original ruling text

July 31, 2012

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 "Taxpayers") for the taxable year ended December 31, 2008. I apologize for the delay in responding to your letter.

FACTS

The Taxpayers, residents of Virginia, paid income tax to another country on the gain of the sale of property located in * (Country A) for the 2008 taxable year. The Taxpayers claimed a tax credit on their federal income tax return for the income tax paid to another country. When Computing the Virginia taxable income, the Taxpayers subtracted the gain as foreign source income. Under audit, the Department disallowed the subtraction and issued an assessment.

The Taxpayers paid the assessment and filed an appeal, contending the United States maintains a treaty with Country A that grants a tax credit for foreign source income. The Taxpayer argues that Country A's tax rates are higher than the tax rates within the United States and Virginia's income tax amounts to double taxation. The Taxpayers further avers that the state in which he currently resides allows such a credit.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia have the same meaning as provided in the Internal Revenue Code (IRC), with certain exceptions, unless a different meaning is clearly required. For individual income tax purposes, Virginia generally "conforms" to federal law in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income included in the FAGI of a Virginia resident is subject to taxation by Virginia, unless it is specifically exempt as a Virginia modification pursuant to Va. Code § 58.1-322.

At one time, Va. Code § 58.1-322 did provide a subtraction from FAGI for certain foreign source income. However, the General Assembly specifically repealed the subtraction effective for taxable years beginning on and after January 1, 2003. Because the foreign gain was included in the Taxpayers' FAGI and the Code of Virginia does not permit a subtraction for such income, the Department was correct in disallowing the subtraction on the 2008 income tax return. Virginia's policy has been consistently articulated in P.D. 03-54 (5/3/2003), P.D. 07-1 (2/22/2007), P.D. 8-103 (6/18/2008), and P.D. 09-50 (4/27/2009).

The Taxpayers assert they are entitled to an exclusion of foreign income on the Virginia income tax return because United States tax treaties with other countries are designed to avoid double taxation. In addition, they contend that other states grant a credit for foreign source income.

By reason of their character as legislative grants, statutes relating to exemptions and exclusions 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).

Courts have long recognized that the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event. It is also a long established principle that the risk of double taxation does not violate a taxpayer's constitutional rights. In Guaranty Trust Co. of New York v. Commonwealth of Virginia , 305 US 19 (1938), the United States Supreme Court held that the imposition of an income tax under Virginia laws on income received as beneficiary of a trust established in New York did not violate the Due Process Clause of the Constitution, notwithstanding that the trust was also subject to tax in New York. Nor did such treatment deny equal protection under the United States Constitution.

The Taxpayers assert that a tax treaty between the United States and Country A requires a foreign tax credit on the United States federal income tax returns. However, the Taxpayers have not provided any evidence of such a treaty or provision. Furthermore, while the Taxpayers' assertion may be correct, a foreign tax credit granted on a federal income tax return does not negate the clear action by the Virginia General Assembly to repeal the foreign source income subtraction for Virginia income tax returns effective for taxable years beginning on and after January 1, 2003.

Because the gain on the sale of land in Country A was included in the Taxpayers' FAGI and Virginia's statutes do not permit a subtraction for such income, the Department was correct in disallowing the subtraction on the 2008 income tax return.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4889602222.D