March 7, 2018
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, 2013 and 2014. You also seek a refund of income tax paid for the taxable year ended December 31, 2015. I apologize for the delay in responding to your appeal.
FACTS
The Taxpayers claimed a subtraction for distributions from individual retirement accounts (IRA) and mutual funds on their Virginia individual income tax returns. The Department audited the Taxpayers and disallowed the subtraction for the distributions from the IRA. The Taxpayers appealed, contending that the subtraction should be allowed because the distributions were income from Treasury funds.
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 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 Virginia Code § 58.1-322.
Virginia Code § 58.1-322 C 1 provides, in pertinent part, a subtraction for:
Income derived from obligations, or on the sale or exchange of obligations, of the United States and on obligations or securities of any authority, commission or instrumentality of the United States to the extent exempt from state income taxes under the laws of the United States including, but not limited to, stocks, bonds, treasury bills, and treasury notes ....
To the extent that income from obligations or securities of the United States is included in FAGI, it may be subtracted for Virginia income tax purposes in computing Virginia taxable income. This Virginia statute codifies the exempt status of income from obligations of the United States set forth in 31 U.S.C. § 3124(a), which provides, in pertinent part:
Stocks and obligations of the United States Government are exempt from taxation by a State or political subdivision of a State. The exemption applies to each form of taxation that would require the obligation, the interest on the obligation, or both, to be considered in computing a tax.
The types of instruments of the United States subject to this exemption are those typically purchased by investors as interest bearing instruments. Income from United States treasury bills, notes and bonds are exempt from state taxation. See Public Document (P.D.) 94-281 (9/16/1994).
Pursuant to P.D. 89-180 (5/31/1989), dividends received from a mutual fund that invests exclusively in exempt United States or Virginia obligations are exempt from Virginia income tax. In addition, income from a retirement fund that invests solely in federal obligations must be characterized as income from federal obligations and as exempt from state taxation by 31 U.S.C. § 3124(a). See Keys v. Vermont Department of Taxes, 149 Vt. 658, 552 A.2d. 418 (1987) citing American Bank v. Trust Co. v. Dallas County, 463 U.S. 855 (1983). Accordingly, income received from an IRA that invests in Treasury bills, notes and bonds is exempt. If the IRA invests in federal or state obligations some of which is taxable, the entire income is taxable unless the portion of the exempt income can be substantiated. See P.D. 89-180.
As such, the portion of the distributions from the Taxpayers' IRA that were derived from United States instruments qualify for the subtraction under Virginia Code § 58.1-322 C 1. The case will be remanded to the auditor to be adjusted in accordance with this determination. The Taxpayers must provide any documentation required by the auditor to make the adjustment.
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/1222.B