The Department denied our FDC subtraction because we didn't take a matching FDC addition in an earlier year -- but we only bought into these S corporations in 2015. Do we still qualify?

Plain-English summary

A married couple filed a joint 2016 Virginia return claiming "fixed date conformity" (FDC) subtractions passed through to them from their ownership interest in two S corporations. FDC subtractions and additions exist because Virginia's income tax "conforms" to a fixed, specific date in the Internal Revenue Code rather than automatically following every subsequent federal tax law change -- when federal and Virginia depreciation (or similar) rules diverge, an ADDITION in one year is often matched by a corresponding SUBTRACTION in a later year, as the difference between federal and Virginia treatment evens out over time.

The Department disallowed the couple's subtractions on a single ground: its records showed the couple hadn't reported an FDC ADDITION in an earlier taxable year, so (in the Department's view) there was nothing for this later subtraction to offset. The couple appealed, and the Tax Commissioner sided with them, citing two of the Department's own recent rulings establishing a clear rule: an FDC subtraction can't be denied SOLELY because a taxpayer's own return doesn't show a matching prior-year addition. If the Department believes an addition really was missed, the proper fix is to go back and CORRECT that earlier year's return (within the statute of limitations) -- and if the real error happened at the PASS-THROUGH ENTITY level (the S corporation itself), the Department must audit and adjust the entity's own return, with any correction then flowing through to the entity's owners, not just deny the current owner's subtraction outright.

Applying that rule here, the key fact was simple: the couple didn't acquire their ownership interest in these S corporations until 2015. Any FDC additions from BEFORE that point would have belonged to the corporations' PREVIOUS owners, who would have reported them (if at all) on their own individual returns -- not this couple's. A later change in ownership doesn't retroactively strip a new owner's ability to claim subtractions the corporation itself properly reported and passed through. Because the couple's subtractions matched what the corporations' own federal and Virginia pass-through entity filings actually reported, the subtractions were valid, and the Department abated the assessment.

What this means for you

New owners of a pass-through entity (S corp, partnership, LLC) claiming an FDC subtraction

Don't assume the Department can deny your subtraction just because YOUR OWN prior individual returns don't show a matching addition -- if you weren't yet an owner when that addition should have been reported, it would have belonged to a PRIOR owner, and that has no bearing on your right to claim a subtraction the entity itself properly passed through to you now.

Pass-through entity owners facing an FDC-related assessment based on "no prior addition"

Point the Department to this rule (and the two rulings it's built on, P.D. 20-31 and P.D. 20-44): a missing prior-year addition, even if real, has to be corrected at its actual source -- either your own prior individual return (within the statute of limitations) or, if the error originated with the entity itself, an audit and adjustment of the ENTITY's return that then flows through to its owners. A blanket denial of your current subtraction isn't the correct remedy.

Buyers acquiring an ownership stake in an S corporation or other pass-through entity

Confirm what FDC additions/subtractions the entity has already reported before and after your purchase -- while your OWN eligibility to claim a subtraction doesn't depend on proving a pre-acquisition addition (that's the prior owners' history, not yours), understanding the entity's FDC timeline can help you anticipate future subtractions or additions tied to your ownership period.

Citations and references

• P.D. 20-31 (3/4/2020) and P.D. 20-44 (3/18/2020) (an FDC subtraction cannot be denied solely because a taxpayer did not report a matching FDC addition in a prior year; any needed correction must be made at its actual source -- the taxpayer's own prior-year return within the statute of limitations, or an audit and adjustment of the pass-through entity's return if the error originated there)

Subject

Pass-through Entity : FDC Subtraction - Proof of prior addition not required

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-112

Original ruling text

August 24, 2021

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 assessment issued to * (the “Taxpayers”) for the taxable year ended December 31, 2016. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayers, a husband and wife, filed a joint Virginia individual income tax return for the 2016 taxable year, claiming fixed date conformity (FDC) subtractions passed through to the Taxpayers as a result of the husband’s ownership interest in two subchapter S corporations. Under review, the Department disallowed the subtractions on the basis that the Taxpayers had not reported FDC additions in prior taxable years and issued an assessment. The Taxpayers appeal, contending the FDC subtractions on their return are correct.

DETERMINATION

In Public Document (P.D) 20-31 (3/4/2020) and P.D. 20-44 (3/18/2020), the Department determined that FDC subtractions cannot be denied based solely on the fact that a taxpayer did not take a FDC addition in a prior taxable year. Those determinations also state that, if the Department determines there has been an error in reporting an FDC addition in prior taxable years, then the Department must correct the taxpayer’s return for the taxable year in which an addition was required but not taken. As such, correction must be made within the applicable statute of limitations. Further, if the Department ascertains there has been a reporting error on the returns provided by the pass-through entity (PTE), then the Department must audit and make adjustments at the PTE level. Such adjustments would then be passed through to the owners of the PTE.

In this case, the Taxpayers did not acquire the ownership interest in the S corporations until 2015, which likely explains why no FDC additions were previously reported on their individual returns. Any prior FDC additions would have been attributed to the corporations, and passed through to its previous owners. A change of ownership would have had no impact on the Taxpayers’ ability to claim FDC subtractions properly reported by the corporations.

Because the Taxpayers properly reported their FDC subtractions as indicated on their federal and Virginia PTE tax forms, they are entitled to claim the subtractions on their 2016 Virginia joint individual income tax returns. Accordingly, the assessment at issue will be abated.

The Code of Virginia sections and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s website. 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/3429-C

Related Documents

20-44

20-31