23 Va. Admin. Code § 10-110-141

Current through Register Vol. 41, No. 3, September 23, 2024

Section 23VAC10-110-141 - Virginia taxable income; additions

To the extent excluded from FAGI, the items enumerated below shall be added to FAGI in computing Virginia taxable income. (For the ACRS addition, see 23VAC10-110-150.)

1. Interest on obligations of other states and certain obligations of the United States.

a. Obligations of other states. Interest on obligations of any state other than Virginia or on the obligations of a political subdivision of such other state or interest or dividends on obligations or securities of any authority, commission or instrumentality thereof which are exempt from federal but not state income tax must be added to FAGI. The amount to be added shall be reduced by the expenses not deducted in computing federal adjusted gross income.

b. Certain obligations of the United States. Interest on obligations or securities of the United States or any commission, authority or instrumentality thereof, which is exempt from federal income tax but which is not exempt (under federal law) from state income tax must be added to FAGI. The amount to be added shall be reduced by expenses not deducted in computing FAGI.

c. Expenses deductible in computing the addition are those which by virtue of IRC § 265 (which prohibits the deduction of expenses allocable to or interest on indebtedness incurred or continued to purchase or carry on obligations exempt from federal income tax) are not deductible for federal purposes.

Example: Taxpayer has $2,500 in interest income from obligations of State X and $500 in interest from obligations of Virginia. None of this $3,000 in interest is subject to federal income tax. "A" incurs $300 in expenses related to this interest income which, by virtue of IRC § 265 was not deductible in computing FAGI. The amount of interest income to be added to FAGI in computing Virginia taxable income is computed as follows:

$2,500 (taxable State X interest)
-	[300 (nondeductible x expenses) X	$2,500	- taxable State X interest]
		$3,000	- total interest
= $2,250

The total nondeductible interest expenses are proportioned between interest taxable in Virginia (State X) and that not subject to Virginia tax (Va.) to determine the portion of these expenses which may be deducted in computing the interest addition.

If the interest is on an obligation created by a compact or agreement to which this state is a party, such interest shall not be added to FAGI in computing Virginia taxable income.

d. Regulated investment companies. Interest on any obligations taxable under subdivisions 1 a or 1 b of this section which is received by a regulated investment company and passed through to the shareholders in qualifying distributions as defined in IRC § 852 shall be taxable in the hands of the shareholders and must be added to FAGI (to the extent excluded therefrom) in computing the shareholder's Virginia taxable income.

2. Interest eligible for federal interest exclusion.

a. To the extent excluded from FAGI pursuant to the provisions of IRC § 128 and accompanying Treasury Regulations, interest income must be added to FAGI in computing Virginia taxable income. Interest income which is not includable in Virginia taxable income, i.e., interest on obligations of the U.S. or Virginia as defined in 23VAC10-110-142, is not required to be added to FAGI even if it is excluded by virtue of the net interest exclusion under IRC § 128.

b. The amount of the net interest exclusion to be added to FAGI in computing Virginia taxable income shall be proportionally reduced by the expenses not deducted in computing FAGI. Expenses deductible in computing the addition are those which by virtue of IRC § 265, which prohibits the deduction of expenses allocable to or interest on indebtedness incurred or continued to purchase or carry on obligations exempt from federal income tax, are included in federal adjusted gross income.

3. Lump sum distributions. Individuals who elect to use the 10-year averaging method for computation of the tax on a lump sum distribution from a qualified employee's trust shall add to FAGI:

(i) 40% of the capital gain part and all of the ordinary income part of such distribution where the election is made to use the 10-year averaging method for the capital gain portion as well as the ordinary income portion; or

(ii) all of the ordinary income portion where the 10-year averaging method is not used for the capital gain portion. The amount to be added is reduced by the minimum distribution allowance and any amount excludable for federal income tax purposes. The amount excludable for federal income tax purposes includes the death benefit exclusion and federal estate tax, if applicable. The minimum distribution allowance for state purposes is the allowance computed for federal purposes and may not exceed the taxable (40%) portion of the capital gain (if such gains are included in the 10-year averaging election) plus the ordinary income portion of the distribution. Where a distribution consists of both capital gain and ordinary income but the 10-year averaging method is not elected for the capital gain portion, the death benefits and federal estate tax exclusion must be allocated to the capital gain and ordinary income portion respectively based upon the percentage of the total taxable distribution represented by each.

Example: A qualifying lump sum distribution consists of $40,000 in ordinary income and $10,000 in capital gain. The taxpayer elects to use the 10-year averaging method only for ordinary income. The death benefit exclusion is $3,000, the minimum distribution allowance is $5,000 and federal estate taxes are $8,000. The amount of the distribution to be added to FAGI in computing Virginia taxable income is computed as follows:

$40,000		ordinary income
	(5,000 - min. distr. allowance x		40,000	- ord. income
	50,000	- total distribution) +
	(3,000 - death ben. exclusion x		40,000	+
	50,000)			+
	(8,000 - estate taxes x		40,000	= $27,200
	50,000)			= $27,200

Therefore, the amount of the lump sum distribution to be added is $27,200, calculated by subtracting the proportional share of excludable amounts (death benefit exclusion, minimum distribution allowance and estate taxes) attributable to the ordinary income portion from the ordinary income.

The effect is to add to FAGI that portion of a lump sum distribution which is excludable from FAGI by virtue of the special 10-year averaging method of computing the tax, less the minimum distribution allowance and death benefits exclusion.

A qualified employee's trust is one from which lump sum distributions qualify for treatment under the 10- year averaging method plan pursuant to IRC § 402. (For computation of the standard deduction as it relates to lump sum distributions, see subdivision 1 b of 23VAC10-110-143.)

4. Two-earner married couple deduction. The amount deducted from federal adjusted gross income pursuant to the provisions of IRC § 221 shall be added to FAGI in computing Virginia taxable income. IRC § 221 allows a deduction in the computation of FAGI for a percentage of the earned income of the lower earning spouse in the case of married persons filing joint federal income tax returns, both of whom have earned income. The amount of the addition shall be equal to the amount deducted in computing FAGI. Where a husband and wife elect to compute their Virginia tax liabilities separately, the federal deduction must be added to the income of the spouse whose earned income was used in computing the deduction for federal income tax purposes.

Example 1: H and W, a husband and wife with no dependents, filed a joint federal income tax return in taxable year 1982 and qualified for a two-earner married couple deduction of $500. The deduction was based upon the income of H, the lower earning spouse, pursuant to IRC § 221. H and W file a joint Virginia return, have FAGI of $28,000, and do not itemize their deductions.

Their Virginia taxable income is computed as follows:

FAGI		$28,000
Less:	Va. Standard Deduction	(2,000)
Less:	Personal Exemptions	(1,200)
Plus:	Federal 2-Earner Deduction	500
Va. Taxable Income		$25,300

Therefore, their Virginia taxable income is $25,300 and their Virginia tax liability is $1,234.75.

Example 2: Assume the same facts as Example 1, except that H and W elect to file separately on a combined Virginia return. H's income is $10,000; W's income is $18,000. Their Virginia tax liabilities are computed as follows:

		H	W
FAGI		$10,000	$18,000
Less:	Va. Standard Deduction	---	(2,000)
Less:	Personal Exemptions	(600)	(600)
Plus:	Federal 2-Earner Deduction	500	---
Va. Taxable Income		$9,900	$15,400

Therefore H's Virginia taxable income is $9,900 and his tax liability is $364.38, W's Virginia taxable income is $15,400 with a tax liability of $665.36, and H and W's total Virginia tax liability is $1,034.74. H must add the two-earner deduction since the federal deduction was based upon his earned income.

23 Va. Admin. Code § 10-110-141

Derived from VR630-2-322 § 2, eff. January 21, 1987; amended, eff. February 1, 1987.

Statutory Authority

§§ 58.1-203 and 58.1-322 of the Code of Virginia.