June 29, 2017
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek a correction of individual income tax assessments issued to ***** (the “Taxpayer”) for the taxable years ended December 31, 2013 through 2015.
FACTS
The Taxpayer, a Virginia resident, was employed in ***** (State A) from 1977 to 1997, in Virginia from 1997 to 2000, in ***** (State B) from 2001 through 2004, and back again in Virginia from 2004 until she retired in 2005. The Taxpayer made contributions to her employer's pension fund during her employment. Upon retirement, the Taxpayer began receiving pension payments from the pension fund in the form of an annuity payable in monthly installments.
The Taxpayer claimed a subtraction on her 2013 through 2015 Virginia income tax returns for the full amount of her taxable contributions. Under review, the Department disallowed the subtractions and issued an assessment. The Taxpayer appealed and provided her own calculations of the subtraction.
DETERMINATION
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 Internal Revenue Code (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 federal adjusted gross income (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 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 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 cases where the year-end value of the pension fund is not available, the Department has 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.
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 to and from funds that can be moved depending on the objectives of the owner of the account. Also, it is possible that an individual may have lived in several different states, and made retirement plan contributions under both conformity and nonconformity rules.
The subtraction is only permitted for certain contributions to a retirement fund. Some states require that employee contributions to retirement be added back to taxable income when subtracted for federal purposes from FAGI. The subsequent distribution of the retirement income of Virginia residents is subject to tax in Virginia, resulting in a taxpayer paying income tax in some other state on the retirement contributions while paying tax in Virginia on the distribution. The General Assembly created the subtraction to alleviate this double taxation.
The Taxpayer contends that she made contributions to her retirement account while she worked in State A and State B. She determined the subtraction amounts by calculating her basic annuity, which was based on all contributions made by both she and her employer. Because state tax statutes can change, it may be difficult to determine if the contributions met the statutory requirements during the years the Taxpayer lived in each state. In addition, the Taxpayer has not been able to provide any documentation of the contributions other than federal information returns.
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., at al. v. Virginia Department of Taxation, Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983). As such, it is incumbent upon the taxpayer to prove they are entitled to a subtraction reported on a Virginia return.
Based on the information provided, the assessments must be upheld. As such, the Taxpayer's request for relief is denied. An updated bill, with interest accrued to date, will be sent to the Taxpayer. The outstanding balance should be paid within 30 days of the bill to avoid additional interest charges.
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 *****.
Sincerely,
Craig M. Burns
Tax Commissioner
AR/1104.B