Could a permanently disabled taxpayer subtract third-party sick pay reported on Form W-2 from Virginia taxable income?

Subject

Temporary sick pay that does not qualify for the subtraction under Va. Code § 58.1-322 C 4 b.

Plain-English summary

The taxpayer could not use Virginia's disability-income subtraction for third-party sick pay reported as wages on Form W-2. The taxpayer proved permanent disability with letters from the insurer, employer, and Social Security Administration, but the Commissioner said eligibility depended on the classification of the payment, not disability status alone.

The ruling treated qualifying disability income as amounts reported on Form 1099-R from pensions, annuities, retirement or profit-sharing plans, IRAs, and insurance contracts. Sick pay reported as wages on Form W-2 was temporary sick pay and did not qualify under Va. Code § 58.1-322 C 4 b. The 2004 assessment therefore remained due.

What this means for you

• Proof of permanent disability does not by itself make every disability-related payment eligible for the subtraction.
• The tax form and legal classification of the payment matter: this ruling distinguished Form W-2 sick pay from qualifying Form 1099-R disability income.
• Review the payment source and reporting before claiming the subtraction.

Common questions

Q: Why was the subtraction denied if the taxpayer was permanently disabled?
A: Because the payment was classified and reported as W-2 sick-pay wages rather than qualifying disability income.

Q: What reporting did the ruling associate with qualifying income?
A: It cited P.D. 06-63 and described qualifying disability income as reported on Form 1099-R.

Q: What happened to the assessment?
A: The request for abatement was denied, and the Department said it would issue a revised bill with accrued interest.

Citations and references

• Va. Code § 58.1-322 C 4 b.
• IRC §§ 22(c)(2)(B)(iii) and 3402(o)(2)(C).
• P.D. 06-63 (Aug. 6, 2006).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-171

Original ruling text

September 11, 2008

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 assessment issued to * (the "Taxpayer") for the taxable year ended December 31, 2004.

FACTS

The Taxpayer is permanently disabled and receives a federal Wage and Tax Statement (Form W-2) that reported third-party sick pay as income in 2004. The Taxpayer subtracted this income as disability income pursuant to Va. Code § 58.1-322 C 4 b on his 2004 Virginia income tax return. The Department disallowed this subtraction on the basis that third-party sick pay reported on a Form W-2 is not disability income subject to the subtraction. The Taxpayer contends that the income constitutes disability income because he is being compensated due to a permanent disability.

DETERMINATION

Virginia Code § 58.1-322 C 4 b provides a subtraction from federal adjusted gross income of up to $20,000 for certain disability income as defined under Internal Revenue Code (IRC) § 22(c)(2)(B)(iii). Disability income is defined under this section as the total amount paid under an employer's accident and health plan or pension plan that is included in an individual's gross income as wages or payments for time the employee is absent from work because of a permanent and total disability.

In Public Document (P.D.) 06-63 (8/6/2006), the Department addressed the scope of the subtraction, concluding that disability income eligible for the Virginia subtraction is reported on the federal form for distributions from pensions, annuities, retirement or profit-sharing plans, IRAs, and insurance contracts (Form 1099-R). Sick pay (including third-party sick pay) reported as wages under IRC § 3402(o)(2)(C) and reported on Form W-2 does not qualify for the Virginia subtraction for disability income.

The Taxpayer has provided a letters form the insurer, employer and the Social Security Administration (SSA) proving that the Taxpayer is permanently disabled. The determination of whether income qualifies for the subtraction, however, is based classification of the income, not just whether an individual is disabled or not.

In this case, the insurer issued the Taxpayer a W-2 reporting wages. Such wages are considered temporary sick pay that does not qualify for the subtraction under Va. Code § 58.1-322 C 4 b. Accordingly, the Taxpayer's request for the abatement of the 2004 tax assessment must be denied.

A revised bill, with interest accrued to date, will be sent to the Taxpayer. No additional interest will accrue provided the outstanding balance in paid within 30 days from the date of the revised bill.

The Code of Virginia sections and public document cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If your have any questions about this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-2352000071.B