April 15, 2015
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, 2011 through 2013.
FACTS
The Taxpayers, a husband and wife, were Virginia residents during the taxable years at issue. The husband was employed by a nonprofit organization located in ***** (State A) while residing in ***** (State B) from 1985 through 2001. During his employment, the husband made contributions to a deferred compensation plan established pursuant to Internal Revenue Code (IRC) § 403(b). In 2002, the husband rolled over his contributions to the deferred compensation plan into an individual retirement account (IRA). After moving to Virginia, the husband took distributions from the IRA. Although the contributions were excluded from federal adjusted gross income (FAGI), they were included in the husband's compensation subject to State B income tax.
The Taxpayers claimed subtractions on their 2011 through 2013 Virginia income tax returns for the full amount of distributions from the IRA.
The Taxpayers were audited by the Department and the subtraction for the distributions was disallowed. The Taxpayers appeal the assessments, contending that they should be permitted to exclude the entire amount of the distributions from the computation of Virginia taxable income for each of the taxable years at issue.
DETERMINATION
It is well established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In People of State of New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937), the United States Supreme Court explained "What the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized." Accordingly, Virginia is well within its authority to impose its income tax on all of the income of a resident of the Commonwealth of Virginia.
Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the IRC unless a different meaning is clearly required. For individual income tax purposes, Virginia "conforms" to federal law, in that it starts the computation of Virginia taxable income with FAGI. Income 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 Va. Code § 58.1-322. 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 § 401 of the Internal Revenue Code, an individual retirement account or annuity established under § 408 of the Internal Revenue Code, a deferred compensation plan as defined by § 457 of the Internal Revenue Code, 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.
State B law provides that contributions made by an employee to a retirement benefits plan, including a deferred compensation plan under IRC § 403(b), may not be excluded from a taxpayer's income. As such, because the contributions to the husband's retirement system were included in his income, the Taxpayer would be eligible to subtract the distributions from the IRA to the extent contributions were subject to tax in *****. While the contributions made to the deferred compensation plan are eligible for the subtraction under Va. Code § 58.1-322 C 19, income generated by those contributions are not.
The complexity of calculating the portion of a retirement plan distribution attributable to previously taxed income was recognized by the Department and communicated to the General Assembly when enacted by House Bill 875 (Chapter 624, Acts of Assembly) in 1996. In its Fiscal Impact Statement (FIS), the Department explained that it is generally difficult, if not impossible, to determine what portion of a distribution would be a return of a contribution or income generated from the investments because deferred compensation plan accounts can include multiple investment vehicles in which income is usually reinvested and to and from which funds can be moved depending on the objectives of the owner of the account. Also, it is possible that an individual lived in several different states, and made retirement plan contributions under both conformity and nonconformity rules.
By reason of their character as legislative grants, statutes relating to deductions and subtractions allowable in computing income and credits allowed against a tax liability must be strictly construed against the taxpayer and in favor of the taxing authority. See Howell's Motor Freight, Inc., et al. v. Virginia Department of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).
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 Va. Code § 58.1-322 C 19 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).
In this case, the Taxpayers' records only show the contributions the husband made from September 1997 through December 2002. The documentation does show the balance of the IRA account as of the September 1997 date. However, this balance likely includes income on the investment. Therefore, the information provided by the Taxpayers is insufficient to show the balance of the husband's previously taxed contributions.
Under the provisions of Va. Code § 58.1-205 any proceeding relating to the interpretation of the tax laws of Virginia, an "assessment of a tax by the Department shall be deemed prima fade correct." As such, the burden of proof is on the Taxpayer to show they were not subject to income tax in Virginia. Accordingly, a taxpayer must provide sufficient documentation showing the balance of previously taxed contributions, the value of the retirement account at the end of the taxable years the subtraction is claimed, and the total amount of any annual distribution. Such documentation may include, but is not limited to, paystubs detailing contribution amounts, investment records and tax returns filed in the state where the contributions were made.
The Taxpayer will be granted one last opportunity to provide the information required to show the amounts of the husband's previously taxed contributions. The documentation must be provided within 30 days from the date of this letter. Please send the requested information to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attn: *****. If sufficient documentation is not
provided within the 30 day period, the assessments will be upheld and an updated bill will be issued with interest accrued to date.
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 ***** at *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1-5909566180.B