Could an employed taxpayer subtract disability payments from Virginia income because the injury arose during combat-zone training?

Plain-English summary

Virginia upheld the assessments because the claimed state subtraction did not fit the returns as filed. The taxpayer subtracted disability income for 2007 through 2009, but audit information indicated that he was gainfully employed while receiving it.

Virginia started with federal adjusted gross income. Its disability subtraction covered qualifying wage-replacement income for a period when an individual was absent from work because of permanent and total disability. Continued gainful employment conflicted with that requirement.

The taxpayer argued that the injury arose during training to serve in a combat zone. The ruling explained that qualifying military- or terror-related disability amounts may instead be excluded from federal gross income under IRC § 104. If the payments should never have entered FAGI, they could not also support a Virginia subtraction from FAGI. The proper route was to amend the federal returns and then the Virginia returns.

What this means for you

• Separate a federal income exclusion from a Virginia subtraction.
• Confirm whether disability payments were included in FAGI before claiming a state modification.
• Document whether you were absent from work because of permanent and total disability.
• If federal treatment was wrong, correct the federal return before conforming the Virginia return.

Common questions

Q: What two conditions did Virginia identify for its disability subtraction?
A: Receipt of qualifying disability income and absence from work because of permanent and total disability.

Q: Why did the military-injury argument not establish the Virginia subtraction?
A: It pointed to a possible federal exclusion; an amount excluded before FAGI is not subtracted again from FAGI by Virginia.

Q: What could the taxpayer do if the payments were wrongly included federally?
A: File amended federal and Virginia returns.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322(C)(4)(b).
• IRC §§ 22(c)(2)(B)(iii), 72, 104, 105(a), and 692.

Subject

Taxpayer was gainfully employed while receiving the disability income.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-179

Original ruling text

October 25, 2011

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This is in response to your letter in which you seek correction of the individual income tax assessments issued to * (the "Taxpayer") for the taxable years ended December 31, 2007 through 2009. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer claimed a subtraction for disability income received during the 2007 through 2009 taxable years. Under audit, the Department discovered information that indicated the Taxpayer was gainfully employed while receiving the disability income. As a result, the Department disallowed the subtractions and issued assessments for additional tax and interest. The Taxpayer appeals the assessments, contending the disability income was exempt from Virginia income tax because the injury resulted from training to serve in a combat zone.

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 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 Va. Code § 58.1-322.

Virginia Code § 58.1-322 C 4 b provides an individual income tax subtraction for up to $20,000 of disability income as defined under IRC § 22(c)(2)(B)(iii). "Disability income" is defined under this section of the IRC to be:

[t]he aggregate amount includable in the gross income of the individual for the taxable year under section 72 or 105(a) to the extent such amount constitutes wages (or payments in lieu of wages) for the period during which the individual is absent from work on account: of permanent and total disability.

Based on the statutory requirements, an individual must meet two tests in order to be allowed a subtraction for disability income.

1. The individual must receive disability income, and

2. The individual must be absent from work because of a permanent and total disability.

The Taxpayer avers the disability income is excluded from Virginia income tax, because the disability resulted from injuries incurred while training to serve in a combat zone. IRC §104 provides a deduction from "gross income" for amounts received by an individual as disability income, attributable to injuries; incurred as a direct result of a terroristic or military action as defined in IRC § 692. Such benefits are not included in FAGI .

The subtraction made under Virginia Code § 58.1-322 C 4 b is limited to the amount of disability income included in FAGI. If the disability pay should not have been included in FAGI, it cannot be eligible for the subtraction. Accordingly, the assessments are upheld. If the disability income was inadvertently included in the FAGI on his federal returns, the Taxpayer will need to file amended returns for both federal and state income tax purposes.

The Code of Virginia sections cited 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 regarding this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4697116163.D