Tax Type
Individual Income Tax
Description
Pension payments
Topic
Taxable Income
Date Issued
12-21-1993
December 21, 1993
Re: §58.1-1821 Application: Individual Income Tax
Dear*****************
This will reply to your letter of April 30, 1993 in which you filed a protective claim for refund for taxable years 1988, 1989, 1990, 1991, and 1992. The protective claim for refund is based upon the Minnesota Supreme Court's decision in the case of Robert E. Meunier v. Minn. Dep't of Revenue (C4-92-1626).
Virginia is not bound by the judicial decisions of the court system of any other state, including Minnesota. In addition, your refund claims for taxable years 1988 and 1989 were filed outside of the three-year period of limitations. Therefore, your protective claim is hereby rejected; however, based upon the authority granted the Tax Commissioner pursuant to Va. Code §58.1-1824, I shall treat your correspondence as an application for correction of an assessment and claim for refund for taxable years 1990-1992 pursuant to Va. Code §§58.1-1821 and 58.1-1822.
BACKGROUND
The taxpayer in Meunier is a federal retiree who received monthly annuity payments for the Civil Service Retirement and Disability Fund (the "Pension Fund") in taxable year 1986. The Pension Fund is required to invest a certain percentage of its assets in federal obligations.
States are prohibited by 31 U.S.C. §3124(a) from imposing a tax on interest and dividends earned on obligations of the United States. States are not, however, prohibited from imposing an income tax upon retirees' pension income as long as all retirees are subject to the tax.
The taxpayer argued that since the Pension Fund is required to invest a certain amount of its assets in federal obligations, the earnings of which are not taxable by the states, the portion of the retirement income received which is attributable to interest from such obligations is, therefore, not taxable by the state.
The taxpayer in Meunier was successful at a Minnesota district court. However, the Minnesota Supreme Court reversed the lower court decision holding that federal retirement annuity payments are taxable by the state. Meunier v. Minnesota Department of Revenue,______Minn. _______ (1993) (copy enclosed).
FACTS
You are a federal retiree who receives pension annuity payments from the Pension Fund. You assert that since a portion of the income the Pension Fund earns is derived from investments in federal obligations, which Virginia is prohibited from taxing, a portion of your retirement income should also not be subject to taxation.
DETERMINATION
Internal Revenue Code ("IRC") §61 specifically lists pension income as a component of gross income which is subject to taxation. Retirement pay, pensions, and other retirement incentives are compensation for past services, which are taxable. Treas. Reg §1.61.1-11. The pension payments you receive from the Pension Fund must be included in your gross and adjusted gross income amounts reported to the Internal Revenue Service (the "Service") and are taxable by the federal government as ordinary income.
As a conformity state, Virginia taxable income is based upon the amount of federal adjusted gross income reported to the Service with certain adjustments (Virginia does not provide a specific deduction for pension income; however, it does provide taxpayers who are 62 and older with an age deduction). The net amount of your pension income subject to Virginia taxation is equal to the amount of pension income you included in federal adjusted gross income, less the Virginia Age Deduction, if applicable.
Pension plan distributions are taxable as ordinary income. Treas. Reg. §1.61.1-11. Typically, a distribution of pension benefits which is generated from a pension trust's sale of an investment at a gain will not result in the treatment of the pension distribution as capital gain income. Rather, the income is treated as ordinary income to the recipients.
There is no pass through attribution rule for pension benefit payments. To the contrary, federal law specifically treats such payments as ordinary income. This is true whether a pension fund invests in federal, municipal, or private investment vehicles. Generally, pass through attribution rules only apply when there is a specific IRC provision authorizing such treatment.
For example, when a partnership earns income, the character of the income in the hands of the partners will be the same as it was in the hands of the partnership since IRC §702 specifically requires such treatment. Similarly, any income that is passed through to a shareholder of an S corporation will retain the same character as it had when the corporation realized the income. IRC §1366.
Unlike a partnership's or an S corporation's investment in a nontaxable investment which would generate nontaxable income for the partners and shareholders, respectively, the Pension Fund's payment of pension benefits which are generated from an investment in federal obligations and which yield nontaxable interest and dividends do not retain the same character when paid to you. The pension income you received is taxable as ordinary income by the federal government and by the Commonwealth.
Therefore, there is no basis to allow your claim for a refund of taxes paid to the Commonwealth on your pension income for taxable years 1990 through 1992. Such income is ordinary income and fully taxable by Virginia. Your claim for refund is hereby denied.
Sincerely,
W. H. Forst
Tax Commissioner
OTP/69680
Rulings of the Tax Commissioner