Should Virginia compute an Arizona resident's reciprocal credit using Arizona tax before or after credits for tax paid to other states?

Plain-English summary

Arizona residents claimed Virginia's reciprocal nonresident credit for tax paid to Arizona. Virginia originally applied the income ratio to Arizona tax after reducing it for credits paid to other states.

The ruling held that Va. Code § 58.1-332 B required the Virginia-source-to-Arizona-income ratio to be applied to the entire Arizona tax. Reducing Arizona tax first by other-state credits understated the Virginia credit, so the Department recalculated it and adjusted the assessment.

Citations and references

• Va. Code § 58.1-332 B

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-4

Original ruling text

January 5, 2018

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessment issued to your clients, * (the “Taxpayers”), for the taxable year ended December 15, 2015.

FACTS

The Taxpayers filed a Virginia nonresident individual income tax return for the 2015 taxable year and claimed a credit for income tax paid to Arizona. Under review, the Department adjusted the credit and issued an assessment. The Taxpayers appealed, contending the Department's computation of the credit was erroneous.

DETERMINATION

Generally, 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. This code section further states:

The credit . . . shall not be granted to a resident individual when the laws of another state, under which the income in question is subject to tax assessment, provide a credit to such resident individual substantially similar to that granted by subsection B of this section.

Under Virginia 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.

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

Virginia Code § 58.1-332 B further provides:

[T]he amount of such tax payable under this chapter shall be credited with such proportion of the tax so payable by him to the state where he resides, upon proof of such payment, as his income subject to taxation under this chapter bears to his entire income upon which the tax so payable to such other state was imposed.

In this case, the Taxpayers claimed credit on their Arizona return for income tax paid as nonresidents to other states besides Virginia. The Department applied the proportion of the Taxpayers' Virginia taxable income over their Arizona taxable income to the Taxpayers' Arizona tax, as reduced by credits for taxes paid to other nonresident states. The statute, however, requires that the income proportion be applied to the entire tax paid to Arizona.

Enclosed is a schedule showing the allowable credit, computed in accordance with Virginia Code § 58.1-332 B. The assessment will be adjusted accordingly.

The Code of Virginia sections 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/1453.M