Rulings of the Tax Commissioner
Corporation Income Tax
IRC § 199 deduction was properly allocated for Virginia income tax purposes
Assessment; Federal Conformity; Subtractions and Exclusions
November 1, 2011
This will reply to your letter in which you seek correction of the corporate income tax assessments issued to ***** (the "Taxpayer"), for the taxable years ended May 31, 2006 and 2007. I apologize for the delay in responding to your letter.
The Taxpayer, commercially domiciled in ***** (State A), files a consolidated corporate income tax return with its subsidiaries for federal income tax purposes. In Virginia, the Taxpayer and a number of affiliated entities file separate returns.
The Department audited the Taxpayer and made several adjustments. Specifically, the auditor disallowed the domestic production activities deduction permitted under Internal Revenue Code (IRC) § 199. The auditor's adjustments resulted in assessments of additional corporate income tax. The Taxpayer appeals the assessments, contending it could properly claim the IRC § 199 deduction on a separate company basis for Virginia income tax purposes.
IRC § 199 Deduction
IRC § 199(a) allows a domestic production activities deduction for taxable years 2005 and 2006 of 3% (6% for 2007 through 2009, and 9% for 2010 and years thereafter) of the lesser of a taxpayer's qualified production activities income (QPAI) or taxable income (adjusted gross income for individuals, trusts, and estates) for a taxable year. Pursuant to IRC § 199(c)(1), a taxpayer's QPAI is equal to the taxpayer's domestic production gross receipts less the sum of the cost of goods sold and other expenses, losses, or deductions (other than IRC § 199 deductions) allocable to such receipts. In addition to the taxable income limitation, the deduction cannot exceed 50% of the W-2 wages paid by the taxpayer. See IRC § 199(b)(1).
IRC § 199(d)(4) provides that special rules apply to deductions claimed by members of expanded affiliated groups. An expanded affiliated group (EAG) is a group of consolidated and non-consolidated members that meet certain ownership requirements. See IRC § 199(d)(4)(B). An EAG is treated as a single corporation for purposes of the deduction, and the deduction is allocated among the members of the EAG in proportion to each member's respective amount of QPAI. See IRC § 199(d)(4). Such allocations are made regardless of whether the EAG member has taxable income or loss or W-2 wages for the taxable year. See Treas. Reg. § 1.199-7(c)(1).
An EAG is treated as a single corporation for purposes of the deduction. As such, the QPAI, taxable income, and W-2 wage limitations apply at the EAG level, not at the taxpayer level regardless of whether the EAG members filed separate or consolidated returns. Accordingly, an EAG's IRC § 199 deduction is equal to 3% of the lesser of the EAG's QPAI or the EAG's aggregate taxable income for the 2005 and 2006 taxable years.
The domestic production activities deduction of the consolidated group is allocated to its, members in proportion to each member's QPAI. See Treas. Reg. § 1.199-7(d)(5). If a member of the consolidated group has negative QPAI, the QPAI of the member is zero. In allocating the deduction among consolidated group members, any redetermination of a corporation's receipts, cost of goods sold, or other deductions from an intercompany transaction under Treas. Reg. § 1.1502-13(c)(1)(i) or (c)(4) is not taken into account. Accordingly, the percentage of the total EAG deduction allocated to a consolidated group member would be the same regardless of whether it was treated as a separate or consolidated taxpayer.
§ 58.1-301 provides that terminology and references used in Title 58.1 of the
Code of Virginia
have the same meaning as provided in the Internal Revenue Code (IRC), with certain exceptions, unless a different meaning is clearly required. For individual income tax purposes, Virginia generally "conforms" to federal law, in that it starts the computation of Virginia taxable income with federal adjusted gross income (FAGI).
Currently, Virginia conforms to the IRC as it existed on December 31, 2010. There are six exceptions to this conformity. One of the exceptions is to allow only 2/3 of the domestic production activities deduction permitted under IRC § 199. This exception is effective for taxable years beginning on or after January 1, 2010.
The Virginia Administrative Code (VAC) requires a taxpayer that files a consolidated federal return, but a separate Virginia return to compute the federal taxable income of each member of the group as if separate federal returns had been filed. See Title 23 VAC § 10-120-320 D 1 b. In cases in which a taxpayer files a consolidated return as part of an affiliated group for federal income tax purposes, but files a separate Virginia return for Virginia income tax purposes, the taxpayer may claim its proportional share of the IRC § 199 deduction for Virginia income tax purposes as provided under Treas. Reg. § 1.199-7(d)(5) because this amount would be the same had it filed separate federal returns.
An examination of the Taxpayer's return shows that the IRC § 199 deduction was properly allocated for Virginia income tax purposes. As such, the assessments have been adjusted in accordance with the enclosed schedule and adjusted audit reports. The outstanding balance should be paid within 30 days of the date of this letter to avoid additional interest charges. The Taxpayer should remit payment to: Virginia Department of Taxation, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attn: *****.
Code of Virginia
sections cited are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If you have any questions regarding this determination, you may contact ***** at *****.
Craig M. Burns