Must Virginia subtract federal savings-bond income again when calculating the income limit for its Age Deduction?

Plain-English summary

Virginia did not have to subtract United States savings-bond income a second time when applying the income limitation for the Age Deduction. The Department denied the taxpayer's refund claims.

The married Virginia taxpayer, who met the age requirement, had cashed matured United States savings bonds. The taxpayer argued that including the tax-exempt bond income in adjusted federal adjusted gross income reduced the available Age Deduction and therefore indirectly taxed the federal-obligation income.

The Department disagreed. Under Va. Code § 58.1-322(C)(1), income from United States obligations that is exempt from state tax was already subtracted in arriving at Virginia taxable income. The Age Deduction was an additional deduction with its own statutory income test.

For a taxpayer born after January 1, 1939 who had reached age 65, the statute then allowed an Age Deduction of up to $12,000, reduced dollar-for-dollar when adjusted federal adjusted gross income exceeded $50,000 for a single taxpayer or $75,000 for married taxpayers. The statutory definition removed specified Social Security and IRC § 86 benefits, but not income from federal obligations.

The Department said it could not create a second subtraction that the General Assembly had not included. Because the federal-obligation income had already been excluded from Virginia taxable income, using it in the separate deduction-eligibility calculation did not impose state tax on that income.

What this means for you

• Excluding income from taxable income is different from excluding it from every limitation used to calculate a deduction.
• The Age Deduction formula follows the benefit categories expressly named in the statute.
• A taxpayer could not receive a second subtraction for the same federal-obligation income through the Age Deduction calculation.
• The dollar amounts and thresholds discussed are the historical rules addressed in this 2013 ruling.

Common questions

Q: Was United States savings-bond income included in Virginia taxable income?
A: No. The ruling said qualifying income from federal obligations was subtracted under Va. Code § 58.1-322(C)(1).

Q: Why could the income still affect the Age Deduction?
A: The separate income test subtracted only the categories specified by the General Assembly.

Q: Did the taxpayer receive the requested refunds?
A: No. The Department denied refunds for the taxable years identified in the conclusion.

Citations and references

• 31 U.S.C. § 3124.
• Va. Code § 58.1-322(C)(1) and (D)(5)(b).
• IRC § 86.
• Deputy v. du Pont, 308 U.S. 488 (1940).
• P.D. 02-108 (July 1, 2002).
• P.D. 10-54 (May 7, 2010).

Subject

Virginia Age Deduction and Obligations of the United States

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-5

Original ruling text

January 10, 2013

Re: Ruling Request: Virginia Age Deduction and Obligations of the United States

Dear *:

This is in response to your letter, dated October 9, 2012, requesting a ruling addressing whether Virginia's Age Deduction computation imposes a tax on tax-exempt income derived from obligations of the United States.

FACTS

In 2007, 2008, 2011 and 2012, * (the "Taxpayer"), a married citizen of Virginia, cashed United States savings bonds that had reached maturity. Upon reviewing his 2011 Virginia tax return, the Taxpayer discovered that the income resulting from his United States savings bonds had not been subtracted from his adjusted federal adjusted gross income ("AFAGI") in computing the Age Deduction.

Under Va. Code § 58.1-322 D.5.b., the Age Deduction is $12,000 for taxpayers born after January 1, 1939 who have attained the age of 65. However, the amount of the deduction is reduced by $1 for every $1 that AFAGI exceeds $50,000 for single taxpayers or $75,000 for married taxpayers. The Virginia Code defines AFAGI as "federal adjusted gross income minus any benefits received under Title II of the Social Security Act and other benefits subject to federal income taxation solely pursuant to § 86 of the Internal Revenue Code."

Tax-exempt income derived from obligations of the United States is not subtracted from FAGI in calculating AFAGI. Because the Taxpayer's AFAGI exceeded $75,000 in 2007, 2008 and 2009, and he had tax-exempt income derived from obligations of the United States in those years, his Age Deduction was less than it would have been if such income had been subtracted from his AFAGI.

The Taxpayer contends that Virginia is taxing tax-exempt income derived from obligations of the United States by failing to remove such income from the calculation of the Age Deduction and that he is entitled to refunds for the 2007, 2008 and 2011 taxable years.

DETERMINATION

Under 31 U.S.C. § 3124, obligations of the United States government are exempt from state taxation. That exemption also applies to each form of taxation that would require income derived from obligations of the United States to be considered in computing a tax. Although Virginia starts with federal adjusted gross income, which includes tax-exempt income derived from obligations of the United States, under Va. Code 58.1-322 C.1., income derived from obligations of the United States that are exempt from state income taxes is subtracted from Virginia taxable income. Therefore, Virginia taxable income does not include tax-exempt income derived from obligations of the United States.

From Virginia adjusted gross income, the General Assembly has allowed individual taxpayers to claim additional deductions in arriving at Virginia taxable income. Among them are a standard or itemized deduction, and an amount for the taxpayer, spouse and dependents. One of these deductions from Virginia adjusted gross income, the Age Deduction, is a deduction of up to $12,000 per year for each taxpayer that meets certain age and income qualifications. The taxpayer clearly meets the age qualification, but disputes how the General Assembly has structured the income qualification.

Solely for the purpose of determining a taxpayer's qualification for the Age Deduction, the General Assembly defined "adjusted federal adjusted gross income" as federal adjusted gross income ("FAGI") less specified classes of income. The taxpayer contends that tax­-exempt income derived from obligations of the United States should also be deducted from FAGI in computing AFAGI. It should be noted that in no event will the computation of this deduction result in an increase in Virginia adjusted gross income, which has already been reduced once by the amount of any tax-exempt income derived from obligations of the United States. The Taxpayer contends that he should receive a second deduction for such interest, effectively subtracting up to twice the amount of his tax-exempt income derived from obligations of the United States in the course of calculating his Virginia taxable income.

In general, a taxpayer does not have a right to any tax deduction. "Credits, deductions or exemptions allowed in the computation of an income tax are privileges accorded as a matter of legislative grace and not as a matter of taxpayer right." Public Document (P.D.) 02-108 (7/1/2002). See also Deputy v. duPont , 308 U.S. 488 (1940). Further, "deductions allowable in computing income allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority." P.D. 10-54 (5/7/2010). Therefore, the Virginia General Assembly may base the computation of deductions on any reasonable basis.

While acting within their discretion to create deductions with reasonable computations, the Virginia General Assembly clearly excluded Social Security benefits and other benefits subject to taxation under IRC § 86 from AFAGI. If the General Assembly wanted to allow a second deduction for tax-exempt income derived from obligations of the United States, it could have done so, but did not. The Department relies on the statutory computation created by the legislature and cannot administratively create a new formula.

CONCLUSION

For the foregoing reasons, the manner in which Virginia computes the Age Deduction does not impose a tax on tax-exempt income derived from obligations of the United States. Therefore, the Taxpayer is not entitled to refunds for the 2007, 2008 and 2011 taxable years. The Code of Virginia sections cited are available online at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's website. If you have additional questions, please contact * in the Office of Tax Policy, Policy Development Division, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

PD/1-5213217858