How did Virginia limit a resident's credit for Delaware income tax when Delaware computed nonresident tax using an allocation percentage?

Plain-English summary

Virginia upheld reductions to a resident's credits for Delaware income tax paid. Virginia's credit was limited to the lesser of the tax actually paid to Delaware or the Virginia income tax imposed on the income earned or derived there.

Delaware first computed tax as if the nonresident were a resident, then applied an allocation percentage. For Virginia's credit numerator, the Department applied that allocation percentage to Delaware net taxable income computed on the resident basis. It rejected the taxpayer's use of modified adjusted gross income because that pre-deduction amount was not the net income on which Delaware imposed tax and would distort the Virginia limitation.

The Department also found that Virginia's Schedule OSC instructions put the taxpayer on notice that an allocation percentage might need to be applied. It emphasized that form instructions are helpful guidance, not authoritative substitutes for statutes, regulations, rulings, and court decisions.

Common questions

Was the credit automatically equal to all Delaware tax paid? No. It could not exceed Virginia tax on the Delaware income actually subject to tax.

Which Delaware income amount entered the Virginia fraction? Allocated Delaware net taxable income, not modified adjusted gross income.

How was the amount derived? Delaware's nonresident allocation percentage was applied to net taxable income computed as if the taxpayer were a Delaware resident.

Could the taxpayer rely only on form instructions? No. The ruling said instructions are guidance and do not replace controlling tax authorities.

Citations and references

• Va. Code §§ 58.1-322 A and 58.1-332 A, as cited in the ruling
• 23 VAC 10-110-221
• Va. Code § 58.1-1821

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-186

Original ruling text

October 30, 2018

Re: § 58.1-1821 Appeal: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessments issued to * (the “Taxpayer”) for the taxable years ended December 31, 2014 through 2016.

FACTS

The Taxpayer filed Virginia resident individual income tax returns for the 2014 through 2016 taxable years and claimed a credit each year for income tax paid to the State of Delaware. Under review, the Department allowed only a portion of the credits claimed and issued assessments. The Taxpayer paid the assessments and appealed, contending he properly computed the credits.

DETERMINATION

Out-of-State Tax Credit

As a matter of fairness and equity, most states, including Virginia, provide a mechanism to relieve residents from being taxed by both their state of residence and the state in which the income was derived. Virginia’s method of limiting taxation of income by more than one state has been to permit a credit for taxes paid to other states pursuant to Virginia Code § 58.1-322. By reason of their character as legislative grants, however, statutes relating to 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).

Virginia Code § 58.1-322 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state provided the income is either earned or business income or gain on the sale of a capital asset. Virginia law does not necessarily allow a taxpayer to claim a credit for the total amount of tax paid to another state. Rather, the credit is limited to the lesser of the amount of tax actually paid to the other state or the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state. The limitation is computed by multiplying the individual’s Virginia tax liability by a fraction, the numerator of which is the income upon which the other state’s tax is imposed and the denominator of which is Virginia taxable income. See 23 Virginia Administrative Code (VAC) 10-110-221.

Like Virginia, Delaware starts the income tax computation of nonresidents by determining the individual’s Delaware taxable income as if they were a resident. The income tax computed as if the individual were a “resident” is converted to a “nonresident tax” by applying a fraction, the numerator of which is a modified adjusted gross income from Delaware sources, and the denominator of which is a modified federal adjusted gross income. See Public Document (P.D.) 95-151 (6/12/1995).

The Department has previously ruled on the method in which a Virginia resident will compute a credit for income tax paid to states that determine the tax on a nonresident as if he or she was a resident. See P.D. 94-91 (3/29/1994) and P.D. 16-147 (7/20/2016), each dealing with New York income tax. See also P.D. 95-174 (6/27/1995) (Minnesota), P.D. 06-45 (4/11/2006) (Iowa), P.D. 15-58 (4/3/2015) (Maryland), P.D. 16-147 (7/20/2016) (Arkansas), and P.D. 18-73 (5/2/2018) (Vermont).

While the Taxpayer correctly points out that his Delaware return does show income attributable to Delaware, the amount reported is a modified adjusted gross income from Delaware sources and is not the income on which the tax is based. Because the denominator of Virginia’s computation of the out-of-state tax credit is Virginia taxable income, using modified adjusted gross income before allowing statutory deductions would distort the credit computation. As a result, the Department finds that Delaware’s consideration of a nonresident’s income as used in its tax calculation has no relevance in computing the credit limitation imposed by Virginia Code § 58.1-332 A. The Virginia credit limitation clearly contemplates a net taxable income on which the other state imposes its tax. Therefore, the Department finds its written policy as described in the aforementioned rulings to be appropriate for a Virginia resident in computing a credit for income tax paid to Delaware.

In P.D. 94-91, the Department required that the allocation percentage calculated on the New York nonresident return (which was used to convert the resident tax to the nonresident tax) must be applied to the New York taxable income calculated as a resident in order to determine the New York nonresident taxable income. The result was used in the numerator of the fraction to compute the limitation imposed by Virginia Code § 58.1-322 A. An analysis of the Delaware and New York nonresident individual income tax formulas shows these computations to be the same in all material respects. See P.D. 95-151.

In this case, the Department applied the allocation percentage calculated on the Delaware nonresident return to the amount of net taxable income computed as a resident to determine Delaware taxable income for purposes of computing the limitation imposed by Virginia Code § 58.1-322 A. As such, the Department’s adjustment properly limited the credit to the amount of Virginia income tax imposed on the amount of Delaware income actually subject to tax for the 2014 through 2016 taxable years.

Tax Form Instructions

The Taxpayer contends that the out-of-state tax credit instructions do not clearly indicate what the Taxpayer should report as the income on which the other state’s tax is based. Consistent with the methodology described in P.D. 94-91, the Schedule OSC line instructions included in the Form 760 Resident Individual Income Tax Booklet state:

In some states, the tax is computed on total taxable income (from all sources) and then reduced by an allocation percentage. In these cases, you must multiply the total taxable income shown on the other state’s return by the allocation percentage to determine the amount of [income on which the other state’s tax is based.]

Accordingly, the instructions put the Taxpayer on notice that the credit may be limited. Further, the instructions merely paraphrase the statutes and generally make no reference to the requirements for reporting amounts on a particular line of a return. The information provided in Virginia’s instructions is intended to provide helpful guidance to taxpayers. It is not intended to provide a detailed explanation of every provision or nuance of Virginia’s tax law. In particular, it would not be practical for the Department to provide detailed instructions concerning how to calculate income tax credits for every state, because of the number of states involved, the fact that terminology differs from state to state, and income tax laws can change.

A taxpayer must consult Virginia’s statutes, ruling letters, regulations, court decisions, and other sources of tax jurisprudence in order to compute his Virginia tax liability correctly. The guidance provided in the Department’s tax form instructions is not a substitute for these sources of Virginia’s tax law and may not be relied upon as authoritative when a taxpayer is computing his Virginia taxable income.

CONCLUSION

Based on the methodology described in P.D. 95-151, the Department correctly limited the credits the Taxpayer claimed for income tax paid to Delaware to the amount of Virginia income tax imposed on the income he earned in Delaware during the 2014 through 2016 taxable years. Accordingly, the Taxpayer’s request for correction cannot be granted and the assessments are upheld. Because the assessments have been paid, no further action is required.

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 contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1689.C