Could nonresident individuals claim Virginia's corporate foreign-income subtraction on S-corporation income passed through trusts?

Plain-English summary

Virginia denied nonresident beneficiaries a foreign-source-income subtraction for 2015 income passed through trusts from an S corporation. S corporations do not pay Virginia corporate income tax; their income and permitted owner-level modifications flow to shareholders.

But the pass-through statute limited individual owners to modifications available under Va. Code § 58.1-322. Virginia's individual foreign-source-income subtraction had been repealed for taxable years beginning on or after January 1, 2003. The taxpayers could not substitute the separate corporate subtraction for the repealed individual provision.

The foreign income included in federal adjusted gross income therefore remained in Virginia taxable income, and the refund was denied.

Common questions

Did the S corporation's status make the corporate subtraction available? No. Owner-level treatment depended on the individual modification statute.

Was this a new policy in 2018? The ruling cites several earlier public documents applying the same rule.

Citations and references

• Va. Code §§ 58.1-301, 58.1-322, 58.1-401, and 58.1-391 A
• P.D. 10-274, P.D. 03-54, P.D. 07-1, P.D. 08-103, and P.D. 09-50

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 18-76

Original ruling text

May 2, 2018

Re: § 1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek a refund of Virginia individual income tax paid by * (the “Taxpayers”) for the taxable year ended December 31, 2015. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayers, a husband and wife, were nonresidents of Virginia. They were the beneficiaries of several trusts that owned an S corporation. The S corporation had Virginia taxable income during the 2015 taxable year.

The Taxpayers filed their 2015 Virginia nonresident individual income tax return claiming a subtraction for foreign source income earned by the S corporation. The Department reviewed the 2015 return and disallowed the foreign source income subtraction, resulting in a reduction of a refund. The Taxpayers appealed, contending that they were entitled to claim the foreign source income subtraction under the corporate statute.

DETERMINATION

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 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.

Virginia Code § 58.1-401 exempts “electing small business corporations” from Virginia corporation income tax. As a result, S corporations are not subject to tax in Virginia. Instead, the income of such corporations is taxed to the shareholders. All pass-through entities, including S corporations, are required to file an annual information return with the Department setting forth their income and a list of their owners. Specifically, Virginia Code § 58.1-391 A provides:

In determining Virginia taxable income of an owner, any modification described in § 58.1-322 that relates to an item of pass-through entity income, gain, loss or deduction shall be made in accordance with the owner's distributive share, for federal income tax purposes, of the item to which the modification relates

Under this statute, any subtraction available under Virginia Code § 58.1-322 will flow through from a pass-through entity to an individual taxpayer, who in turn can take the subtraction on his or her Virginia individual income tax return. The statute, however, limits the type of subtraction modifications passed through from pass-through entities to those permitted under Virginia Code § 58.1-322. See Public Document (P.D.) 10-274 (12/6/2010).

Virginia Code § 58.1-322 does not provide a foreign source income subtraction. Although Virginia Code § 58.1-322 permitted a subtraction from FAGI for certain foreign source income, it was repealed effective for taxable years beginning on and after January 1, 2003. Because the foreign income was included in the Taxpayers' FAGI and the Code of Virginia does not permit a subtraction for such income, the Department was correct in disallowing the subtraction on the 2015 income tax return.

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), and P.D. 09-50 (4/27/2009). Accordingly, the Taxpayers' request for a refund of Virginia income tax paid for the taxable year ended December 31, 2015 is denied.

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/1360.B