Did wages earned and taxed in another country escape Virginia income tax for a Virginia resident in 2013?

Subject

Federal Information, Foreign Adjusted Gross Income, Penalty and Interest, Foreign Source Income, Tax Paid to Another State

Plain-English summary

Virginia treated a resident's 2013 wages earned in another country as subject to Virginia income tax because the wages were included in federal adjusted gross income and no Virginia subtraction applied.

The taxpayer conceded Virginia residency but argued that the income was earned and taxed abroad. Virginia's former foreign-source-income subtraction had been repealed for tax years beginning on or after January 1, 2003. The credit for tax paid to another state also did not apply because the tax was paid to a foreign country, and the separate foreign-country credit covered qualifying pension or retirement income, which the taxpayer did not show.

The assessment was an estimate based on IRS information. The Department allowed 30 days for a 2013 Virginia return so it could recompute the liability. Any remaining penalty could later be considered through an offer in compromise, but interest was mandatory unless the underlying tax changed.

What this means for you

Virginia residents generally cannot remove foreign wages from Virginia taxable income merely because the wages were earned or taxed abroad. Federal exclusion under IRC § 911, a specific Virginia modification, and the narrow foreign-retirement-income credit are separate questions that require supporting information.

Common questions

Does Virginia still have the old foreign-source-income subtraction? No. The ruling says it was repealed for tax years beginning on or after January 1, 2003.

Does Virginia's credit for tax paid to another state cover a foreign country? No. The cited regulation limits that credit to another state.

What foreign tax credit did Virginia law provide here? Va. Code § 58.1-332.1 covered qualifying pension or retirement income taxed by a foreign country, but no such income was shown.

Could the estimated assessment change? Yes. The taxpayer was allowed 30 days to file a 2013 return for review and adjustment.

Could interest be waived? No, except to the extent the underlying tax was adjusted. The ruling described interest as mandatory.

Citations and references

• Va. Code §§ 58.1-301, 58.1-219, and 58.1-322 — federal starting point, adjustment authority, and Virginia modifications.
• IRC § 911 — foreign earned income exclusion discussed in the ruling.
• Va. Code §§ 58.1-332 and 58.1-332.1; 23 VAC 10-110-220 — other-state and foreign-country credits.
• Va. Code §§ 58.1-341 and 58.1-311; IRC § 6103(d) — filing requirement, estimated liability, and federal information.
• Va. Code §§ 58.1-347, 58.1-492, 58.1-105, and 58.1-1812 — penalties, waiver authority, and mandatory interest.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-210

Original ruling text

December 18, 2017

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, 2013. I apologize for the delay in responding to your appeal.

FACTS

The Department received information from the Internal Revenue Service (IRS), indicating that the Taxpayer may have income subject to Virginia income tax for the 2013 taxable year. Under audit, the Department concluded the Taxpayer was a Virginia resident and issued an assessment. The Taxpayer concedes he was a resident of Virginia, but he filed an appeal contending his income was earned in * (Country A) and he paid income tax to Country A. In the alternative, the Taxpayer requests waiver of assessed penalty and interest.

DETERMINATION

Taxation of Residents

It has been well established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In New York ex rel. Cohn v. Graves , 300 U.S. 308, 57 S.Ct. 466 (1937), the United States Supreme Court explained “[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized.” Thus, any resident who has Virginia taxable income as determined under Virginia's statutes is subject to Virginia income tax.

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 Internal Revenue Code (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 Virginia Code § 58.1-322.

Foreign Income Exclusion

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 Virginia Code § 58.1-219.

The Taxpayer claims he lived and worked in Country A in 2013. IRC § 911 allows qualified individuals to exclude a portion of their income attributable to their 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 government reimburses the United States for his salary. See Public Document (P.D.) 12-29 (3/21/2012). The information provided to the Department does not clearly specify whether the income was excluded from FAGI under IRC § 911.

Foreign Source Income Subtraction

Virginia Code § 58.1-322 does not provide modifications for foreign source income; therefore, the income attributed to Country A would properly be subject to tax by Virginia. At one time, Virginia 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 wages were included in the Taxpayer's FAGI and Virginia statutes do not permit a subtraction for such income, the Department was correct in including the income in its computation of Virginia income tax. Virginia's policy has been consistently articulated in P.D. 03-54 (5/3/2003), P.D. 07-1 (2/22/2007), P.D. 08­-103 (6/18/2008), P.D. 09-50 (4/27/2009), and P.D. 15-52 (4/3/2015).

Credit for Tax Paid to Other States

Virginia Code § 58.1-332 allows Virginia residents a credit against their income tax liability when they pay income tax to another state on earned or business income, or on any gain from the sale of a capital asset. The intent of the credit is to grant Virginia residents relief in situations in which they are taxed by both Virginia and another state on these types of income during the same taxable year.

Title 23 of the Virginia Administrative Code (VAC) 10-110-220 provides that the credit “is applicable only to income tax paid to another state and does not apply to taxes paid to any foreign country.” As such, income earned in Country A would not be eligible for Virginia's out-of-state tax credit.

Credit for Tax Paid to Foreign Countries

Virginia Code § 58.1-332.1 provides a credit for income tax paid on any pension or retirement income to a foreign country to the extent that such income is included in federal adjusted gross income, derived from past employment in the foreign country and subject to Virginia income tax. The intent of the credit is to grant Virginia residents relief in situations in which they are taxed by both Virginia and a foreign country on these types of income during the same taxable year. No evidence has been provided to indicate the Taxpayer received retirement income subject to Country A's income tax during 2013.

Computation of Tax

Virginia Code § 58.1-341 provides that a Virginia resident who is required to file a federal income tax return is also required to file a Virginia income tax return unless the resident is exempt from filing under Va. Code § 58.1-321. When a resident does not file a proper Virginia return, IRC § 6103(d) authorizes the Department to obtain information from the IRS that will help in determining the resident's tax liability.

Under Virginia Code § 58.1-311, the Department used information obtained from the IRS as the starting point for computing the Taxpayer's liability. The Department granted the Taxpayer a single exemption and the standard deduction in order to determine income subject to tax. The enclosed worksheet shows the computation in more detail.

Penalties and Interest

The Taxpayer requests a waiver of all penalties and interest applicable to the assessment on the basis that he was not aware of the taxability of his income to Virginia. Pursuant to Virginia Code § 58.1-347, an individual who fails to file a return by t he due date or extended due date of such return is subject to a penalty equal to 6% of the tax liability per month or fraction thereof during which such failure to file continues, not to exceed 30%, in the aggregate. In addition, Virginia Code § 58.1-492 provides for an “addition to tax” (commonly called the estimated tax underpayment penalty) in the event of an underpayment of estimated tax. Under current law, taxpayers are required to make timely income tax payments throughout the year by having tax withheld from wages or making estimated payments. Taxpayers who do not have enough tax withheld from their income must make four estimated tax payments throughout the taxable year. The underestimated penalty and the late filed penalty were applied to the 2013 assessment.

Virginia Code § 58.1-105 grants the Tax Commissioner authority to waive penalty in cases where reasonable cause is demonstrated. Because the assessment is an estimate based on information available to the Department, it is difficult to determine whether there is reasonable cause to waive an assessment.

In regard to the accrued interest, the application of interest to tax underpayments is mandatory under Virginia Code § 58.1-1812, and it cannot be waived unless the associated tax is adjusted. Interest is not assessed as a penalty, but represents a fee for the use of money that was properly due the Commonwealth.

CONCLUSION

Because the Taxpayer was a resident of Virginia for the 2013 taxable year, he was required to file a Virginia individual income tax return. The assessment, however, is based on information made available to the Department. The Taxpayer may have additional information that more accurately reflects his Virginia taxable income. As such, the Taxpayer should file a Virginia income tax return for the 2013 taxable year. The return or payment should be submitted within 30 days from the date of this letter and mailed to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, Attention *, Post Office Box 2475, Richmond, Virginia 23261-7203.

Once the return is received, it will be reviewed and the assessment will be adjusted as appropriate. After the Taxpayer receives a revised bill, he may file an offer in compromise with regard to any penalty assessment remaining due. Interest, however, will not be waived. If the return is not filed or payment not made within the allotted time, the assessment will be upheld as issued and collection actions may resume.

The Code of Virginia sections, regulation, 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 c ontact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1212.o