I work in North Carolina but live in Virginia, and my employer only withheld North Carolina tax -- can I just report that as my Virginia withholding, or use my W-2 alone to claim Virginia's out-of-state tax credit?

Plain-English summary

A husband and wife were Virginia residents but both worked in North Carolina. Their employers withheld North Carolina income tax from their wages but no Virginia tax. On their Virginia resident returns for 2019-2021, they reported the North Carolina withholding AS IF it were Virginia withholding. The Department disallowed that and assessed additional tax; the couple appealed, arguing that denying them credit for the North Carolina tax would mean they're taxed twice on the same income.

The Department agreed they shouldn't be double-taxed in principle, but explained they'd used the wrong mechanism. As Virginia residents, they owe Virginia tax on ALL their income regardless of where it was earned -- but because the withholding actually went to North Carolina, Virginia never received those payments, so it can't be counted as Virginia withholding on their Virginia return. The right tool for double-taxation relief is Virginia's separate OUT-OF-STATE TAX CREDIT (Va. Code § 58.1-332 A), which normally limits the credit to the lesser of the tax actually paid to the other state or the Virginia tax on that same income -- but for a state that BORDERS Virginia, like North Carolina, a special rule applies when the income earned in that single contiguous state is less than the taxpayer's total Virginia taxable income and consists entirely of earned/business income: in that situation, the taxpayer can claim a credit up to the FULL 100% of their Virginia tax liability (still capped at what was actually paid to the other state), not just the proportional amount. The catch: to claim either version of the credit, you must actually be liable for and have paid the other state's tax -- and a Form W-2 showing withholding isn't proof of that, since withholding doesn't account for that state's own exemptions, deductions, or credits that determine actual liability. The couple hadn't even filed North Carolina returns, despite apparently being required to under North Carolina's own nonresident filing threshold. So while their assessments for 2019-2021 stood as issued, the Department gave them a path forward: file North Carolina nonresident returns to establish their actual NC liability, then file amended Virginia returns (with Schedule OSC and full copies of the NC returns) within 60 days, after which the assessments would be adjusted accordingly.

What this means for you

Virginia residents who work in a state that only withholds THAT state's tax (not Virginia's)

Don't report the other state's withholding as if it were Virginia withholding -- Virginia never received that money and will disallow it. Instead, claim Virginia's separate out-of-state tax credit, which requires proof of your actual liability and payment to the other state (typically that state's own filed tax return), not just a W-2.

Virginia residents working in North Carolina or another bordering state

Check whether the special border-state rule applies to you -- if your income from that single contiguous state is less than your total Virginia taxable income and is entirely earned/business income, you may be able to claim a credit for up to 100% of your Virginia tax liability, not just the ordinary proportional amount.

Accountants and tax professionals

When a client works in a neighboring state and only that state withheld tax, get the client's actual nonresident return filed with that state before claiming the Virginia out-of-state credit -- a W-2 alone won't satisfy the Department, which needs the other state's actual computed liability to apply the statutory proportional (or border-state) limitation correctly.

Common questions

Q: Can I report tax another state withheld from my wages as if it were Virginia withholding?
A: No -- if Virginia didn't actually receive the withholding, it can't be credited as Virginia withholding on your Virginia return, even if you're a Virginia resident who owes Virginia tax on that income.

Q: Is a W-2 showing out-of-state withholding enough to claim Virginia's out-of-state tax credit?
A: No -- the credit's proportional limitation requires your actual return filed with the other state, since withholding doesn't reflect that state's exemptions, deductions, or credits that determine your true liability there.

Q: What's special about claiming a credit for tax paid to a state that borders Virginia?
A: If your income from that single contiguous state is less than your Virginia taxable income and is entirely earned/business income, you can claim a credit up to 100% of your Virginia tax liability (capped at what you actually paid the other state), rather than just the ordinary proportional share.

Q: What do I need to do to fix a Virginia assessment caused by claiming out-of-state withholding incorrectly?
A: File the required nonresident return(s) with the other state to establish your actual liability, then file an amended Virginia return (including Schedule OSC and copies of the other state's return) so the credit can be properly calculated and the assessment adjusted.

Citations and references

• Va. Code § 58.1-332 A (out-of-state tax credit; border-state special rule)
• Va. Code § 58.1-322 A (credit requires liability for and payment of the other state's tax)
• Va. Code § 58.1-301 (Virginia conformity to Internal Revenue Code terminology)
• N.C. Gen. Stat. § 105-153.8(a)(2) (North Carolina nonresident filing requirement)
• P.D. 95-174 (6/27/1995) (a copy of the other state's actual return is required to apply the credit limitation)

Subject

Administration: Return - Withholding From Another State Credit: Tax Paid to Another State - North Carolina, Border State Credit

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-30

Original ruling text

March 22, 2023

Re: § 58.1-1821 Application: Individual Income Tax

Dear *

This will reply to your letter in which you seek correction of the individual income tax assessments issued to * (the “Taxpayers”), for the taxable years ended December 31, 2019, through 2021.

FACTS

The Taxpayers, a husband and wife, were residents of Virginia during the taxable years at issue. They both were employed in North Carolina. The Taxpayers’ employers withheld income tax for North Carolina but did not withhold tax for Virginia. The Taxpayers filed Virginia resident returns for the 2019 through 2021 taxable years and reported the tax withheld for North Carolina as the tax withheld for Virginia. The Department disallowed the withholding tax reported on the returns and issued assessments. The Taxpayers appeal, contending that not allowing them a credit for income tax paid to North Carolina would result in double taxation.

DETERMINATION

Taxation of Virginia Residents

Virginia Code § 58.1-301 provides, with certain exceptions, that the 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. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income (VTI) 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 Virginia modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia .

As stated above, because the Taxpayers were Virginia residents, they were subject to tax on all of their income, regardless of the fact that the income was earned in North Carolina. Because the tax was withheld for North Carolina, Virginia never received the tax payments claimed on their Virginia returns as withholding. As such, the Department properly denied credit for the North Carolina withholding the Taxpayers claimed on their Virginia return.

Out of State Tax Credit

The Taxpayers contend that they should receive a credit for the tax that they paid to North Carolina, otherwise they would be paying a double tax on their income. Virginia Code § 58.1-332 A 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. The intent of the credit is to grant Virginia residents relief in situations in which they are taxed by both Virginia and another state on these types of income during the same taxable year.

As a general rule, the credit is limited to the lesser of: (1) the amount of tax actually paid to the other state; or (2) the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state. In the case of a Virginia resident who pays income tax to a state that borders Virginia, like North Carolina, a special rule can apply.

If certain criteria are met, the limitation that restricts the credit to the amount of Virginia income tax actually imposed on the taxpayer on the income derived in the other state is disregarded. The special rule will apply if the income subject to tax in a single state contiguous to Virginia is less than Virginia taxable income and all of the income from sources outside Virginia is earned income or business income reported on federal form Schedule C from that single contiguous state. In such instances, the Virginia resident will be entitled to a credit equal to the lesser of: (1) the amount of income tax actually paid to the contiguous state; or (2) 100% of their Virginia income tax liability. See Virginia Code § 58.1-332 A. Under either rule, in order to claim the credit, Virginia residents must be both liable for and pay the income tax due to the other state. See Virginia Code § 58.1-322 A.

The Taxpayers have indicated that they did not file North Carolina income tax returns, but they have provided copies of their Form W-2s issued by their employers. They contend that the Form W-2s are sufficient to show that they were entitled to claim the out-of-state credit.

However, Virginia Code § 58.1-332(A), in pertinent part, places a limitation on the credit:

The credit allowable under this section shall not exceed: ...such proportion of the income tax otherwise payable by him under this chapter as his income upon which the tax imposed by the other state was computed bears to his Virginia taxable income upon which the tax imposed by this Commonwealth was computed... (Emphasis added).

Because of this limitation on the credit, a copy of Form W-2 showing income tax was withheld by another state is insufficient for the Department to allow this credit. Instead, a taxpayer must provide a copy of the return filed with the other state so that it can be determined if the limitation imposed by Virginia Code § 58.1-332 A is applicable. See Public Document (P.D.) 95-174 (6/27/1995). Moreover, the amount of tax withheld for another state does not necessarily represent a taxpayer’s liability in that state. The amount withheld, for example, does not take into account any additions, exemptions, subtractions, deductions, or credits that may be utilized in calculating a taxpayer’s tax liability.

North Carolina G.S. § 105-153.8(a)(2) provides that nonresident individuals of North Carolina who have income derived from a business, trade, profession, or occupation carried on in North Carolina and meet certain filing threshold amounts are required to file a North Carolina income tax return. Because the Taxpayers’ wages were derived from occupations carried on in North Carolina and exceeded the filing threshold amounts described in North Carolina law, it appears that they were required to file North Carolina nonresident income tax returns.

CONCLUSION

The Taxpayers could not claim income tax withheld and paid to North Carolina as payments of Virginia income tax on their Virginia returns. As such, their request for the abatement of the assessments issued for the taxable years ended December 31, 2019 through 2021 cannot be granted.

The Taxpayers may, however, be able to claim the out of state tax credit for income tax paid to North Carolina. In order to claim the credits, they should file nonresident North Carolina income tax returns to determine their actual North Carolina income tax liability, then they should file amended Virginia income tax returns, including the Virginia Schedule OSC, for the 2019 through 2021 taxable years. The amended returns, including full copies of the North Carolina returns, should be mailed to: Virginia Department of Taxation, Appeals and Rulings, Attn: *, Post Office Box 27203, Richmond, Virginia 23261-7203. The requested documents should be sent within 60 days from the date of this letter. Once the returns are received, they will be processed and the assessments adjusted accordingly. If the Taxpayers fail to respond within the time allowed, the assessments will be considered to be correct.

The Code of Virginia sections and public document 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/4405.B

Related Documents

95-174

97-301

15-61