Could a Virginia resident claim a Virginia credit for California tax paid on capital gain passed through from California rental property?

Subject

California law allows a Virginia resident to claim the credit on the California nonresident return.

Plain-English summary

A Virginia resident received capital gain through a pass-through entity from the sale of California rental property. He paid California tax on the gain, then claimed a credit on his Virginia resident return. Virginia denied the credit and upheld the resulting assessment.

Virginia explained that its reciprocal-credit rule depends on the other state's law. California permits a qualifying nonresident credit for tax paid to the person's resident state and lets a partner or S-corporation shareholder treat a share of entity-paid tax as paid directly. Because the taxpayer appeared able to claim the credit on his California nonresident return, he generally could not instead claim it on the Virginia resident return.

The Department acknowledged that earlier public documents had allowed Virginia credits in some California situations, but the taxpayer's return did not clearly show that any exception applied. On that record, the assessment and denial of the Virginia credit were upheld.

Common questions

Why did paying California tax not automatically create a Virginia credit? For California, Virginia's rule generally places the reciprocal credit on the California nonresident return because California provides a substantially similar credit.

Did the ruling say a Virginia credit is never possible for California tax? No. It cited prior circumstances where Virginia had allowed one, but found that this taxpayer had not clearly shown an applicable exception.

What income produced the disputed tax? Capital gain passed through from a pass-through entity's sale of rental property located in California.

Citations and references

• Va. Code § 58.1-332 B.
• Cal. Rev. & Tax. Code §§ 18002 and 18006.
• P.D. 94-355, P.D. 95-175, P.D. 97-98, P.D. 07-207, P.D. 12-156, and P.D. 13-118.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 16-30

Original ruling text

March 18, 2016

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, 2012.

FACTS

The Taxpayer is a resident of Virginia and a member of a pass-through entity (PTE). During the 2012 taxable year, the Taxpayer received capital gains income on the sale of rental property located in California through the PTE. The Taxpayer filed a California nonresident income tax return and paid income tax on the gain. The Taxpayer also filed a Virginia resident return, and claimed a tax credit for the income tax paid to California. The Department denied the tax credit and issued an assessment for additional tax and interest. The Taxpayer filed an appeal regarding the disallowance of the tax credit.

DETERMINATION

Under Va. Code § 58.1-332 B, a nonresident is permitted to claim a credit against tax on income from Virginia sources when their state of residency provides a substantially similar credit to Virginia residents or imposes a tax upon their income derived from Virginia sources but does not tax income earned in the state by Virginia residents. Because it is dependent on another state granting a similar or reciprocal credit, it may be limited by the credit permitted by the other state. Currently, only residents of Arizona, California, Oregon, and the District of Columbia may qualify for this credit.

Pursuant to Cal. Rev. & Tax. Code § 18006, a member of a partnership or S-Corp is allowed to treat his or her pro rata share of net income taxes paid to another state by the partnership as if those taxes had been paid directly by the partner. In addition, Cal. Rev. & Tax. Code § 18002 provides a tax credit to nonresidents against the net income taxes imposed by and paid to the resident state. Thus, it appears the Taxpayer could qualify for a credit on his California nonresident return.

As indicated above, Virginia law generally does not allow a resident to claim a credit on his Virginia return for taxes paid to California because California law allows a Virginia resident to claim the credit on the California nonresident return. Similarly, a California resident would claim the credit for tax paid to California on his Virginia nonresident return.

Under certain circumstances, the Department has permitted a credit for income tax paid to California. See Public Document (P.D.) 97-98 (2/24/1998) and P.D. 07-207 (12/5/2007). The Department has also addressed a number of issues under which the out-of-state credit would not be permitted. See P.D. 95-175 (6/28/1995), P.D. 12-156 (10/04/2012) and P.D. 13-118 (6/27/2013). A review of the Taxpayer's return does not clearly indicate whether he would be eligible for one of the exceptions.

In P.D. 94-355 (11/23/1994), the Department determined that when a reciprocity state does not allow credit on a nonresident return for individual income tax paid to another state, the individual may claim the credit on the Virginia resident income tax return. Because it appears a credit for income tax paid to Virginia would be allowable on the California nonresident individual income tax return, the Taxpayer would not be eligible to claim an out-of-state tax credit on his 2012 Virginia return. As such, the Department was correct in denying the credit. Accordingly, the assessment is upheld.

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

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-6090177900.D