Can a Virginia resident claim the out-of-state tax credit for the D.C. Unincorporated Business Franchise Tax, and is denying it unconstitutional double taxation?

Plain-English summary

A Virginia resident claimed the out-of-state tax credit on his 2015 return for paying the District of Columbia's Unincorporated Business Franchise Tax (UBFT). The Department disallowed the credit and assessed tax. He appealed, arguing the UBFT is a tax on income, that denying the credit is unconstitutional double taxation under the Commerce Clause, and — in the alternative — that penalty and interest should be waived.

The Department upheld the assessment on every point. The UBFT doesn't qualify for Virginia's credit, denying it doesn't violate the Commerce Clause, and there was no penalty to waive while interest is mandatory.

Why the D.C. UBFT doesn't earn the credit

Virginia gives residents a credit for income taxes paid to another state on earned or business income (Va. Code § 58.1-332 A). But Va. Code § 58.1-332.2 defines a qualifying "income tax" narrowly — a broad-based tax on all of a resident's income, similar to Virginia's own. A tax doesn't qualify if it is (i) labeled a franchise or license tax and (ii) doesn't tax all of the individual's income.

The statute specifically lists the D.C. UBFT, the Texas Margin Tax, and the Ohio Commercial Activity Tax as taxes that do not qualify — even though they may be measured partly by income. Consistent with long-standing policy (P.D. 11-92, P.D. 15-89, P.D. 18-166, P.D. 12-108), the UBFT earns no Virginia credit.

The Commerce Clause argument (and why it failed)

The taxpayer argued that if Virginia won't give the credit, the statute unconstitutionally discriminates against interstate commerce. The Department walked through the U.S. Supreme Court's framework:

• A state may tax all the income of its residents, even income earned elsewhere (New York ex rel. Cohn v. Graves).
• The dormant Commerce Clause bars only tax schemes that discriminate against interstate commerce, tested by the "internal consistency test" from Complete Auto Transit v. Brady and applied in Comptroller of the Treasury v. Wynne.
• That test hypothetically assumes every state has Virginia's tax structure. Under that assumption, Virginia would grant the credit for other states' income taxes and no discrimination attributable to Virginia's structure appears.

The Court in Wynne distinguished two situations: (1) taxes that inherently discriminate — usually unconstitutional; and (2) double taxation that results only from the interaction of two different but nondiscriminatory state schemes — which is not unconstitutional. Any double taxation here falls in the second bucket: it exists because D.C. chose a different kind of tax (the UBFT), not because Virginia discriminates. So there's no Commerce Clause violation. Wynne also noted a state can cure a discriminatory tax in ways other than granting a credit, so Virginia isn't compelled to.

Penalty and interest

• Penalty: none was charged on this assessment, so there was nothing to waive (Va. Code § 58.1-105).
• Interest: mandatory under Va. Code § 58.1-1812. It isn't a penalty — it's a charge for the use of money owed — and it can't be waived unless the underlying tax is adjusted. Since the tax stood, so did the interest.

What this means for you

• Not every out-of-state business tax earns Virginia's credit. Franchise/gross-receipts-style taxes that don't tax all of your income — the D.C. UBFT, Texas Margin Tax, Ohio CAT — don't qualify.
• Some double taxation is constitutional. When it results from two different but nondiscriminatory state tax systems, the Commerce Clause doesn't require Virginia to give a credit.
• Interest follows the tax. Even a good-faith position that loses will carry mandatory interest; only reducing the tax reduces the interest.
• Relying on a preparer's advice doesn't erase interest, though it can matter for penalty (and here there was no penalty anyway).

Common questions

Q: I paid the D.C. Unincorporated Business Franchise Tax. Can I credit it on my Virginia return?

A: No. The UBFT is a franchise tax that doesn't tax all of your income, so it's specifically excluded from Virginia's out-of-state credit.

Q: Isn't being taxed by both D.C. and Virginia unconstitutional double taxation?

A: Not here. The Supreme Court's internal consistency test treats double taxation that arises from two different, nondiscriminatory state tax structures as constitutional. Virginia isn't discriminating against interstate commerce.

Q: Can the Department waive my interest if I relied on my accountant?

A: No. Interest is mandatory and can't be waived unless the tax itself is reduced. (Reliance on advice can support waiving a penalty, but no penalty was assessed in this case.)

Citations and references

• Va. Code § 58.1-332 A — credit for income tax paid to another state
• Va. Code § 58.1-332.2 — definition of "income tax"; franchise/license taxes (UBFT, Texas Margin Tax, Ohio CAT) excluded
• Va. Code § 58.1-105 — offer in compromise; penalty waiver for reasonable cause
• Va. Code § 58.1-1812 — mandatory interest, not waivable unless the tax is adjusted
• Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787 (2015); Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977); New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937)
• Related Virginia rulings cited: P.D. 11-92, P.D. 15-89, P.D. 18-166, P.D. 12-108

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-107

Original ruling text

September 18, 2019

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 * (the “Taxpayer”) for the taxable year ended December 31, 2015.

FACTS

The Taxpayer filed a Virginia resident individual income tax return for the 2015 taxable year, claiming an out-of-state tax credit for payment of the Unincorporated Business Franchise Tax (UBFT) to the District of Columbia. Under review, the Department disallowed the credit and issued an assessment. The Taxpayer appeals, contending he was eligible to claim the credit for the UBFT because it is a tax based on income and denial of the credit would result in double taxation in violation of the Commerce Clause of the United States Constitution. In the alternative, the Taxpayer requests that penalty and interest be abated because he relied on the advice of a tax professional in filing his return.

DETERMINATION

Classification of Tax

Virginia Code § 58.1-332 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. The Department has ruled that the UBFT does not qualify for this credit. See Public Document (P.D.) 11-92 (6/2/2011), P.D. 15-89 (4/28/2015), and P.D. 18-166 (9/26/2018). In addition, Virginia Code § 58.1-332.2 A defines an “income tax” as a term of art that refers to a specific type of tax levied on all of a resident’s earned and unearned income, and all income of nonresidents from sources within the jurisdiction, which is similar to the income tax that Virginia imposes on resident and nonresident individuals. Virginia Code § 58.1-332.2 B includes examples of taxes that do not qualify for the credit, even though they may be measured, in part, by income. Taxes do not qualify because (i) they are labeled as a franchise or license tax, and (ii) they do not tax all income of the individual. Examples of taxes that do not qualify for the credit pursuant to Virginia Code § 58.1-332.2 include the UBFT, the Texas Margin Tax, and the Ohio Commercial Activity Tax. See P.D. 12-108 (7/1/2012). Pursuant to Virginia Code § 58.1-332.2, and in accordance with the Department’s longstanding policy, the UBFT does not qualify for the credit under Virginia Code § 58.1-332.

Commerce Clause

The Taxpayer contends that if he is not permitted a credit pursuant to Virginia Code § 58.1-332, then the statute is unconstitutional in violation of the Commerce Clause of the United States Constitution.

It is well established that a state may tax all the income of a resident, even income from outside the taxing jurisdiction. In People of State of New York ex rel. Cohn v. Graves , 300 U.S. 308 (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.” Most recently, in Comptroller of the Treasury v. Wynne , 135 S. Ct. 1787, 191 L. Ed. 2d 813 (2015), the United States Supreme Court also recognized that a State’s taxation of a resident’s income may be subject to constitutional scrutiny under the Commerce Clause of the United States Constitution.

The Commerce Clause grants Congress power to “regulate Commerce… among the several States.” Art. I, § 8, cl.3. Although the Clause is framed as a positive grant of power to Congress, the Court has consistently held this language to contain a further, negative command, known as the dormant Commerce Clause. Wynne , 135 S. Ct. at 1794. The dormant Commerce Clause prohibits state taxation discriminating against interstate commerce, even when Congress failed to legislate on the subject. Id . To help identify state tax schemes that discriminate against interstate commerce, the Court uses something known as the “internal consistency test.” Id . at 1803. The United States Supreme Court first adopted the “internal consistency test in Complete Auto Transit, Inc. v. Brady , 430 U.S. 274 (1977). The test “looks to the structure of the tax at issue to see whether its identical application by every State in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate.” Wynne , 135 S. Ct. at 1803 (citations and internal quotation marks omitted).

Accordingly, a state is within its authority to impose income tax on all of the income of a resident of that state. A state need only ensure that the income tax, to the extent that it substantially affects interstate commerce, does not discriminate against such commerce. While granting a credit against a resident’s income tax may cure an otherwise discriminatory tax, the Supreme Court in Wynne did not order that. In fact, the Court noted that alternative remedies existed, one of which would be for the state to refrain from taxing nonresidents on certain income. Wynne , 135 S. Ct. at 1806.

Critically, not all situations of double taxation are a result of discriminatory tax schemes. The Court explained:

By hypothetically assuming that every State has the same tax structure, the internal consistency test allows courts to isolate the effect of a defendant State's tax scheme. This is a virtue of the test because it allows courts to distinguish between (1) tax schemes that inherently discriminate against interstate commerce without regard to the tax policies of other States, and (2) tax schemes that create disparate incentives to engage in interstate commerce (and sometimes result in double taxation) only as a result of the interaction of two different but nondiscriminatory and internally consistent schemes...The first category of taxes is typically unconstitutional; the second is not.

Id . (citations omitted).

If a court were to subject Virginia’s credit to the internal consistency test it would assume that all states, including the District of Columbia, imposed a broad-based income tax like Virginia’s and would not analyze the actual taxes imposed by each of the other states. Under that assumption, Virginia would grant the credit for income taxes imposed by the other states and no discrimination would be found to exist that could be attributed to Virginia’s tax structure. The fact that a credit has been denied for the UBFT is attributable to the fact that the District of Columbia has imposed taxes that are significantly different from Virginia’s income tax. This situation fits into the second type of result of the internal consistency test, which does not violate the Commerce Clause of the United States Constitution.

Penalty and Interest

The Taxpayer requests that penalty and interest be abated because he relied on the advice of a tax professional and the Department in filing his return. Virginia Code § 58.1-105 grants the Department the authority to accept an offer in compromise and to waive penalty for reasonable cause. In this case, the Taxpayer was not charged a penalty on the assessment at issue.

Interest is accrued on any late payment of tax, regardless of whether a penalty is imposed. 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 to the Commonwealth. As such, the Department finds no basis for abating any portion of the assessed interest.

CONCLUSION

Under Virginia statutes, the Taxpayer was not eligible to claim a credit for the UBFT imposed by the District of Columbia because it is not a broad-based income tax for which Virginia allows a credit. In addition, contrary to the assertions by the Taxpayer, the denial of the credit in this case does not violate the Commerce Clause of the United States Constitution. The Taxpayer’s alternative request, to waive penalty and interest, cannot be granted because the Taxpayer was not charged a penalty and interest cannot be waived unless the associated tax is adjusted.

Accordingly, the assessment is upheld. The Taxpayer will receive an updated bill with accrued interest to date. The Taxpayer should remit payment of the balance within 30 days of the date of this letter to avoid the accrual of additional interest and collection actions.

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/2044C

Related Documents

11-92

15-89

18-166

12-108