Tax Type
Individual Income Tax
Description
Subtractions from federal adjusted gross income; Lump sum distribution of retirement income
Topic
Taxable Income
Date Issued
03-28-1994
March 28, 1994
Re: §58.1-1821 Application: Individual Income Tax
Dear*******
This will reply to your letters regarding the taxation of your federal retirement income. Specifically, you assert that the imposition of tax on a lump sum distribution you received during taxable year 1989 was a return of capital contributions you made to the plan in earlier years.
FACTS
During taxable year 1989, at your election, you received a lump sum distribution of retirement benefits. During your employment you contributed to the retirement plan with after tax dollars. You claim that the lump sum distribution was a nontaxable return of your after tax contributions to the plan. The department assessed additional taxes on the portion of the lump sum payment which exceeded the amount deemed to be a return of capital for federal tax purposes. A portion of this assessment was recovered from your 1992 income tax refund.
In support of your argument you cite Montgomery v. U.S., 829 F. Supp. 1061 (S.D. Ind. 1993), rev'd, U.S. v. Montgomery, No. 93-3101 (7th Cir. March 10, 1994). Additionally, you protest the department's retention of your 1992 refund.
DETERMINATION
For federal income tax purposes, a retiree's contributions to a retirement plan are treated as being distributed ratably over a predetermined period and not immediately in the initial payments.
Thus, only a portion of an initial lump sum distribution and the subsequent retirement payments can be recovered on a tax free basis. Under Va. Code §58.1-322, Virginia taxable income is federal adjusted gross income, with certain specified modifications. As such, to the extent that income is subject to federal taxation, it will generally be subject to Virginia taxation. Because there is no specific subtraction or deduction in Va. Code §58.1-322 for the type of income you received, the income is included in Virginia taxable income.
Since only a portion of the lump sum distribution you received can be treated as a recovery of your after tax contributions for federal tax purposes, that same portion (and no more) is excluded from Virginia tax. Therefore, the assessment of tax on the taxable portion of your lump sum distribution, which you excluded from income contrary to federal law, was correct.
In support of your assertion you cite the Federal District Court opinion in Montgomery. Although this opinion supports your position, it was reversed by the United States Seventh Circuit Court of Appeals on March 10, 1994. A copy of both opinions are enclosed for your review. A similar challenge to the federal lump sum distribution rules was rejected by the United States Claims Court in Shimota v. U.S., 21 Cl. Ct. 510 (1990). Both the Circuit Court decision in Montgomery and the Claims Court decision in Shimota clearly supports the department's position in this case.
Finally, you protest the department's retention of your 1992 refund which was applied to your 1989 assessment. Pursuant to Va. Code §58.1-1823, the department may reduce any refund by the amount of tax, interest, and penalty due for a prior period. Only if a taxpayer files a protest pursuant to Va. Code §1821 would the department be prevented from offsetting a refund. As your 1821 appeal was not received until well after your 1992 refund was reduced, the offset was proper.
Sincerely,
Danny M. Payne
Acting Tax Commissioner
OTP/74180
Rulings of the Tax Commissioner