Could a Virginia resident employed by NATO exclude qualifying foreign earnings from 2010 Virginia taxable income?

Plain-English summary

Virginia allowed the taxpayer's federal foreign-earned-income exclusion and directed that her refund be adjusted. The taxpayer worked in a foreign country under a three-year contract as a member of NATO's International Staff throughout 2010. She excluded that compensation from federal adjusted gross income, but the Virginia audit added it back on the premise that a United States agency had paid her.

Virginia generally starts with federal adjusted gross income and can adjust it when the federal computation clearly conflicts with the Internal Revenue Code. IRC § 911 generally does not cover compensation paid by the United States, including federal employees loaned to foreign governments.

The taxpayer's documentation, however, showed that NATO employed her. Virginia therefore allowed the IRC § 911(a)(1) exclusion, returned the case to the audit staff for adjustment, and said a refund would be issued.

Common questions

Q: Did the Ottawa Agreement itself decide the Virginia appeal?
A: The ruling's stated conclusion relied on the taxpayer's NATO employment documentation and IRC § 911(a)(1).

Q: Why had Virginia initially disallowed the exclusion?
A: The audit treated the taxpayer as compensated by a United States agency; the later documentation showed NATO employment.

Citations and references

• Va. Code §§ 58.1-219, 58.1-301, and 58.1-322.
• IRC § 911(a)(1).

Subject

Taxpayer is allowed to take advantage of the foreign earned income exclusion

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-29

Original ruling text

March 21, 2012

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you appeal the reduction of the refund claimed on the Virginia individual income tax return filed by * (the "Taxpayer") for the 2010 taxable year. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer filed a 2010 Virginia income tax return, excluding income earned from the North Atlantic Treaty Organization (NATO) in * (Country A) from her federal adjusted gross income (FAGI). Under audit, the Department disallowed the exclusion, and reduced the refund amount claimed by the Taxpayer. The Taxpayer appeals the assessment, contending she was an official employee of NATO and the income earned for services provided to NATO is excluded from taxation within the United States under the Ottawa Agreement.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the IRC unless a different meaning is clearly required. For individual income tax purposes, Virginia "conforms" to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI). Income properly 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.

As a general rule, the Department relies on the accuracy of information and computations reflected on the federal income tax return when reviewing Virginia individual income tax returns. If the information provided on the federal return appears reasonable, there is generally no reason to look behind those computations. However, the Department retains the authority to adjust the FAGI where there is clear evidence that the amounts reported on the federal or Virginia income tax return are not consistent with the IRC. See Va. Code § 58.1-219.

In this instance, the Taxpayer excluded from FAGI the income earned for services provided to NATO. Under audit, the Department adjusted the Taxpayer's FAGI to include the income because the Taxpayer was compensated by an agency of the United States.

IRC § 911 allows qualified individuals to exclude a portion of their income attributable to his presence in a foreign country. Generally, this exclusion does not apply to individuals who are paid by the United States including members of the armed forces, embassies, and federal employees loaned to foreign governments, even if the foreign governments reimburses the United States for his salary.

The Taxpayer has provided documentation showing she was employed by NATO under a three year contract, beginning in 2008. She was employed as a member of the NATO International Staff in accordance with the Ottawa Agreement for the entire 2010 taxable year. As such, the Taxpayer is allowed to take advantage of the foreign earned income exclusion as provided by IRC § 911(a)(1). The assessment will be returned to the audit staff to adjust the assessment according to this determination and a refund will be issued shortly.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4784931235.D