How should Virginia taxpayers report claim-of-right income received in one year and repaid in a later year?

Plain-English summary

A married couple received income in 2016, later had to repay it in 2018, and the husband's employer made the repayment for them. They had paid Virginia tax on both the original payment and the repayment made on their behalf.

Virginia follows the federal claim-of-right treatment. Income received without restriction under a claim of right is included when received, even if it must later be repaid. The relief is taken on the return for the repayment year, not by changing the earlier return.

When a qualifying repayment exceeds $3,000, IRC § 1341 allows the taxpayer to use whichever produces the lower liability:

• deduct the repayment in the repayment year; or
• reduce that year's tax by the tax attributable to including the income in the earlier year.

The Virginia return must follow the federal choice. If the taxpayer uses the tax-reduction method, the Virginia return must include a schedule computing the Virginia consequences and a copy of the federal computation schedule. The Virginia benefit is entered on the line designated for Virginia income tax withheld. The ruling also directed the couple to attach a copy of the ruling letter.

If the IRS later changes the claim amount, Va. Code § 58.1-311 requires a corresponding Virginia amended return within one year.

What this means for you

Claim-of-right relief is coordinated with the federal return. Keep the federal and Virginia computations together, make the adjustment in the repayment year, and be ready to amend Virginia if the IRS changes the federal amount.

Common questions

Can the taxpayer amend the year the income was originally received? Not under the method described. The adjustment belongs on the repayment-year return.

When does IRC § 1341 provide the two-method choice? The ruling describes it for repayments exceeding $3,000.

What must be attached for the tax-reduction method? A Virginia computation schedule and a copy of the federal repayment schedule.

Citations and references

• Va. Code § 58.1-301; §§ 58.1-322.01 through 58.1-322.04; § 58.1-311.
• IRC § 1341.
• P.D. 87-190, 93-48, 06-141, and 16-183 -- prior claim-of-right treatment cited by the ruling.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-35

Original ruling text

March 6, 2020

Re: Request for Ruling: Individual Income Tax

Dear *:

This will reply to your letter in which you request a ruling on the application of the claim of right doctrine to * (the “Taxpayers”).

FACTS

The Taxpayers, a husband and wife, received income in the 2016 taxable year that they were later required to repay in the 2018 taxable year. The husband’s employer made the repayment on behalf of the Taxpayers. The Taxpayers paid tax on both the initial payment and the repayment made on their behalf on their relevant Virginia returns. The Taxpayers request a ruling concerning the appropriate adjustments to the Taxpayer’s Virginia return to correct the inequity.

RULING

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 modification pursuant to Virginia Code §§ 58.1-322.01 through 58.1-322.04.

The claim of right doctrine, as it has been established as a principle of tax law, provides that payments must be included in gross income if the taxpayer receives them without restriction, under a claim of right. This is true even though the taxpayer may discover in a later year that he had no right to the payments and is required to repay the same amount. Under the claim of right doctrine, the taxpayer may deduct the repayments in the year in which they are made.

When the repayments exceed the income for the year of the repayment or when the income (after the subtraction of the repayments) is taxed at a rate lower than that at which the income was taxed in the year of inclusion, the deduction does not compensate the taxpayer adequately for the tax that was originally paid on the inclusion of the income. IRC § 1341 provides a mechanism by which this inequity is corrected in cases in which the repayment exceeds $3,000.

Under the provisions of IRC § 1341, a taxpayer is allowed to either: (1) reduce the tax for the year of the repayment by the amount of tax attributable to the inclusion of the income in the previous year(s), or (2) deduct the amount repaid in the year of the repayment. The taxpayer is allowed to use whichever method results in the lower tax liability. In either case, the adjustment is made to the return for the year of the repayment, not to the prior year’s return in which the income was included.

The Department has consistently held that, in order to maintain conformity with the options available under the IRC, a taxpayer may follow the provisions of IRC § 1341 for Virginia income tax purposes. See Public Document (P.D.) 87-190 (8/5/1987), P.D. 93-48 (3/5/1993), P.D. 06-141 (12/4/2006), P.D. 16-183 (9/14/2016).

When an individual chooses to take a deduction on their federal return, they should similarly claim a deduction on their Virginia return. When an individual chooses to reduce the tax for the year of the repayment by the amount of tax attributable to the inclusion of the income in the previous year(s), a schedule must be attached to the Virginia return detailing the computation of the Virginia tax consequences of the repayment. In addition, a copy of the schedule attached to the federal return, used to compute the federal tax consequences of repayment, must also be attached to the Virginia return. The amount of tax benefit derived from the repayment must be included on the line of the Virginia return designated for Virginia income tax withheld.

The Taxpayers should, therefore, file a Virginia return that conforms to their treatment of the claim of right income for federal income tax purposes. Also, a copy of this letter should be attached to the return claiming the adjustment when it is filed.

The Taxpayers should be aware that unlike other Virginia deductions and credits, the claim of right doctrine is directly tied to IRC treatment. Thus, if the Internal Revenue Service (IRS) changes the claim amount, the Taxpayers will also have the responsibility to file an amended return within one year of such change in order to adjust their Virginia claim accordingly. See Virginia Code § 58.1-311.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2012-C

Related Documents

87-190

87-192

91-222

93-48

06-141

16-183