Could a Virginia resident subtract pension distributions from another state's retirement system?

Subject

States may tax all the income of its residents, even income earned outside the taxing jurisdiction

Plain-English summary

Virginia denied the taxpayer's subtraction for distributions from the New Hampshire state retirement system and upheld the 2004-2006 assessments. As a Virginia resident, the taxpayer could be taxed by Virginia on income from outside the Commonwealth.

The subtraction in Va. Code § 58.1-322 C 19 applied only to the extent retirement-plan contributions had previously been taxed by another state. New Hampshire taxed specified interest and dividend income, not the wages from which the taxpayer's retirement contributions were made. Because those contributions had not been taxed there, the pension distributions did not qualify for the subtraction.

The taxpayer also could not receive a Virginia credit for New Hampshire tax on the pension after moving to Virginia. Under 4 U.S.C. § 114, New Hampshire could not legally impose income tax on the retirement income of a Virginia resident.

What this means for you

• Virginia residents are generally taxable on all income, including pension income earned or paid from another state.
• The cited subtraction focuses on whether another state taxed the contributions when made, not simply whether the pension came from another state.
• Withholding by another state does not create a Virginia credit when that other state was legally barred from taxing the retirement income.
• Different states' lower pension-tax rates do not change the Virginia rates enacted by the General Assembly.

Common questions

Q: Why did the New Hampshire pension fail the Virginia subtraction?
A: The wages used for the pension contributions had not been subject to New Hampshire income tax.

Q: Could the taxpayer claim a credit for New Hampshire tax withheld after moving?
A: No. Federal law prohibited the former state from taxing the retirement income once the taxpayer was a Virginia resident.

Q: Can Virginia tax income earned outside Virginia?
A: Yes. The ruling cites the settled rule that a state may tax all income of its residents.

Q: What happened to the assessments?
A: The request for abatement was denied, and revised bills with accrued interest were to be issued.

Citations and references

• Va. Code §§ 58.1-322 C 19, 58.1-332, and 58.1-320.
• 4 U.S.C. § 114.
• N.H. Rev. Stat. Ann. § 77:4.
• New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937).
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Roanoke City Circuit Court, Law No. 82-0846 (Oct. 27, 1983).
• Article IV, § 15 of the Constitution of Virginia.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 08-173

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 years ended December 31, 2004 through 2006.

FACTS

The Taxpayer was a retired employee of the state of * who received pension distributions from that state's retirement system. The Taxpayer moved to Virginia in 2004. The Taxpayer subtracted the pension distributions from his Virginia taxable income for the 2004 through 2006 taxable years.

The Department disallowed the subtractions and adjusted the Taxpayer's Virginia taxable income, resulting in the assessment of additional income tax and interest for the taxable years at issue. The auditor determined there was no basis to subtract the pension distributions when computing Virginia taxable income. The Taxpayer contends that Virginia should not tax out-of-state pension income.

DETERMINATION

It is well-established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In New York ex rel. Cohn v. Graves , 300 U.S. 308, (1937), the United States Supreme Court explained "[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized."

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., et al. v. Virginia Department of Taxation , Circuit Court of the City of Roanoke, Law No. 82-0846 (10/27/1983).

This case involves Va. Code § 58.1-322 C 19, which 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 § 401 of the Internal Revenue Code, an individual retirement account or annuity established under § 408 of the Internal Revenue Code, a deferred compensation plan as defined by § 457 of the Internal Revenue Code, 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.

Under New Hampshire law, specifically N.H. Rev. Stat. Ann. § 77:4, New Hampshire residents are subject to income tax on interest, dividends and income from certain types of qualified investment companies. As such, contributions to the New Hampshire state retirement system or pension fund made from wages paid to a resident individual are not subject to income tax in New Hampshire. Because the income from which contributions to the Taxpayer's retirement system were made was not subject to taxation, he was not entitled to subtract the pension distributions from his Virginia taxable income for the 2004 through 2006 taxable years.

The Taxpayer contends that the instructions addressing the subtraction of pension distributions do not clearly identify what income may be subtracted. I disagree. The instructions clearly state that the subtraction is for "income received during the taxable year on which the contributions were taxed in another state."

The Taxpayer also argues that the intent of the Virginia legislature was to exempt pension income because Virginia allows for a credit against income taxed by other states. Under 4 U.S.C. § 114, however, no state can impose an income tax on any retirement income of an individual who is not a resident of that state. Under this federal statute, once the Taxpayer became a resident of Virginia, New Hampshire was prohibited from imposing tax on the Taxpayer's retirement income. Thus, even though you represent that New Hampshire income tax was withheld from the pension after you became a Virginia resident, no tax could have been legally paid on the retirement income in a state other than Virginia. Accordingly, no credit could be granted pursuant to Va. Code § 58.1-332.

Finally, the Taxpayer asserts that, even if the New Hampshire pension distributions are subject to Virginia income tax, such tax is inequitable because other states assess less tax on pension distributions. He points to a number of states that assess a lower income tax rate on pension income than their normal rate.

Article IV, § 15 of the Constitution of Virginia grants authority to the General Assembly to enact general laws, including the taxation of its citizens. As such, the rate at which the income of a Virginia resident is taxed is a matter within the authority and responsibility of the General Assembly only. Those rates are established under Va. Code § 58.1-320, which stipulates a maximum rate of 5.75% on all Virginia taxable income.

CONCLUSION

Based on the foregoing, the Taxpayer's request for the abatement of the Virginia income tax assessments for the 2004 through 2006 taxable years is denied. Revised bills, 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 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 you 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/1-2303335894.B