August 10, 2022
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will respond to your letter in which you seek correction of the individual income tax assessment issued to ***** and ***** (the “Taxpayers”) for the taxable year ended December 31, 2018.
FACTS
The Taxpayers, a husband and wife, filed a Virginia resident individual income tax return and each claimed subtractions for pension and IRA contributions previously taxed by ***** (State A) for the taxable year ended December 31, 2018. Under audit, the Department denied the subtraction and issued an assessment for additional tax and interest. The Taxpayers paid the assessment and filed an appeal. The Taxpayers concede that they incorrectly calculated the subtractions, but they request that their assessment be adjusted to reflect the proper subtraction amounts.
DETERMINATION
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.
Virginia Code § 58.1-322.02 11 (formerly Virginia Code § 58.1-322 C 19) provides a subtraction for any income received during the taxable year derived from a qualified pension, profit-sharing, or stock bonus plan as described by IRC § 401, an individual retirement account or annuity established under IRC § 408, a deferred compensation plan as defined by IRC § 457, or any federal government retirement program, the contributions to which were deductible from the taxpayer’s federal adjusted gross income, but only to the extent the contributions to such plan or program were subject to taxation under the income tax in another state. Before taxpayers are permitted to subtract any portion of their retirement income, contributions to the retirement plan must satisfy a two-part test: (1) they must have been deductible for federal income tax purposes; and (2) they must still have been subject to income tax in another state.
In Public Document (P.D.) 10-214 (9/15/2010), the Department established a pro-rata approach that accurately reflects the nature of a distribution from a retirement plan. Accordingly, a taxpayer who receives a distribution from a retirement plan as described in Virginia Code § 58.1-322.02 11 and whose contributions to such plan were subject to income taxation in another state would determine the portion of the annual distribution(s) eligible for the subtraction by multiplying the total amount of the annual distribution(s) by a ratio equal to the total balance of previously taxed contributions divided by the sum of the value of the retirement account at the end of the taxable year plus the total amount of the annual distribution(s). This computation is appropriate for retirement accounts with changing account values such as individual retirement accounts (IRAs) or accounts established under IRC § 401(k) or § 403(b).
The Department has also ruled that a simplified method may be used. See P.D. 15-104 (5/12/2015). Under IRC § 72(d)(1)(B), a simplified method for determining the tax-free portion of pension payments has been established. Under the simplified method, the investment in the contract as of the annuity starting date (the total contributions previously taxed) is divided by a designated number of anticipated monthly payments to determine a monthly non-taxable payment. Assuming annuity payments are made monthly, the non-taxable payment is multiplied by the number of months an annuitant receives payments during the taxable year to determine excludable retirement income. This computation is appropriate for individuals who receive periodic determinable periodic payments from traditional pension plans.
Based on the information provided, it appears that the wife made contributions to a pension plan that were deductible for federal income tax purposes but added back to her state taxable income when she resided in ***** (State A). For the taxable year at issue, she received distributions from the pension plan in equal periodic payments. As such, the wife qualified for the subtraction, as computed using the simplified method.
It appears that the husband’s pension contributions were made using after tax dollars and thus were not deductible for federal income tax purposes. If so, a portion of the husband’s pension distributions would already have been excluded from federal taxable income as a return of contribution, and thus, the distributions would not have been eligible for the subtraction.
The Taxpayers have also indicated that they made contributions to other plans such as those established under IRC §§ 401(k), 403(b) and 457 as well as IRAs. Although it appears that these contributions generally were deductible for federal income tax purposes and added back to their State A taxable income, it is unclear, for example, which contributions were made to which accounts, which accounts were active as of 2018, or whether and when any rollovers may have occurred. Without additional information to clarify the history and status of these accounts, the Department is unable to determine the extent the Taxpayers may have been eligible for the subtraction. Ultimately, taxpayers bear the burden of proving they are eligible for a subtraction.
A schedule showing what portion of the wife’s pension distributions was eligible for the subtraction is enclosed. The Department will allow sixty additional days for the Taxpayers to submit further information to establish their eligibility for the subtraction as to any distribution made from any of their other retirement accounts. Such information must be sent to *****, Tax Examiner, Sr., Office of Compliance, Desk Audit, Office Audit Unit 3, P.O. Box 615, Richmond, Virginia 23218-0615. The information will be reviewed, the assessment will be adjusted as appropriate, and a refund will be issued accordingly. If the information is not received in the time allotted, the assessment will be adjusted to account for that portion of the wife’s pension distributions that was eligible for the deduction, but the assessment will otherwise be considered to be correct.
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 determination, you may contact ***** in the Office of Tax Policy, Appeals and Rulings, at *****. If you have any questions regarding the information you must submit, you may contact ***** at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/3975.B