Did low-wage service work disqualify a disabled federal retiree from Virginia's disability-income subtraction?

Subject

Low-wage service work did not defeat disability subtraction

Plain-English summary

Virginia abated the 2008-2010 assessments because the taxpayer's minimum-wage service job was not comparable to his former federal-government work. The Department had previously denied the disability-income subtraction on the theory that he was engaged in substantial gainful activity.

On reconsideration, the income was identified as a federal retirement annuity governed by the IRC § 72 disability standard. That rule evaluated the impairment plus education, training, and work experience, and compared the new activity to work customarily performed before disability.

The taxpayer's later service-industry work paid minimum wage and was materially different from his prior government duties. With the additional evidence, Virginia found no comparable substantial gainful activity and abated the assessments.

What this means for you

• Some post-disability work does not automatically eliminate the subtraction.
• The nature of the work matters, not only the amount earned.
• Identify whether payments come from an annuity or an accident or health plan because different federal rules can apply.

Citations and references

• Va. Code § 58.1-322 C 4 b.
• IRC §§ 22, 72, and 105.
• Treas. Reg. § 1.72-17(f).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-65

Original ruling text

May 15, 2014

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek reconsideration of the Department's determination letter, issued as Public Document (P.D.) 13-50 (4/24/2013), to * (the "Taxpayer") for the taxable years ended December 31, 2008 through 2010. I apologize for the delay in responding to your request.

FACTS

In P.D. 13-50, the Department determined the Taxpayer was engaged in a substantial gainful activity and did not qualify for the disability income subtraction. The Taxpayer seeks a redetermination, contending the income was received from an annuity or life insurance plan instead of an accident or health insurance contract. The Taxpayer claims the standards for substantial gainful activity for proceeds from annuities require that the activity must be comparable to the activity in which an individual was engaged prior to the disability.

DETERMINATION

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 Internal Revenue Code (IRC) § 22(c)(2)(B)(iii). This IRC section provides a federal income tax credit for a portion of disability income as defined under IRC § 72 or IRC § 105(a) to the extent such income constitutes wages, or payments in lieu of wages, for the period of time during which an individual is absent from work due to permanent and total disability.

Under IRC § 105(a), income received through accident or health insurance policies is generally taxable, unless an exclusion applies. IRC § 105(d), which provided an exclusion for disability income, was repealed in 1983. This exclusion was eventually replaced by a tax credit provided under IRC § 22. Under IRC § 22(e)(3), "permanent and total disability" is defined as follows:

[a]n individual is permanently and totally disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.

In evaluating the whether the Taxpayer was engaged in substantial gainful activity, the Department applied the rules set forth in Treas. Reg. § 7.105-2. See P.D. 13-50. The Taxpayer asserts that his disability income during the taxable years at issue was not received through an accident or health insurance policy. Instead, the disability income resulted from a federal retirement annuity subject to the statutory requirements of IRC § 72.

Under IRC § 72(a)(1), gross income generally includes any amount received as an annuity under an annuity, endowment or life insurance contract. IRC § 72(m)(7) defines "disabled" in substantially the same terms as IRC § 22, and grants the Internal Revenue Service discretion as to proof required to show the existence of a disability. Pursuant to Treas. Reg. § 1.72-17(f),

[I]n determining whether an individual's impairment makes him unable to engage in any substantial gainful activity, primary consideration shall be given to the nature and severity of his impairment. Consideration shall also be given to other factors such as the individual's education, training, and work experience. The substantial gainful activity to which section 72(m)(7) refers is the activity, or a comparable activity, in which the individual customarily engaged prior to the arising of the disability (or prior to retirement if the individual was retired at the time the disability arose).

During the taxable years at issue, the Taxpayer was employed in the service industry where he was paid at the minimum wage rate. The Taxpayer contends that his wages for the taxable years at issue did not constitute substantial gainful employment because they were only equivalent to 25% of his pre-retirement income.

In light of the additional information provided with your request for reconsideration and given the Taxpayer's training and work experience with his employment with the United States government, it is my determination that the nature of his employment during the taxable years at issue was not comparable to work he was required to perform prior to his impairment. Therefore, the Taxpayer was not engaged in substantial gainful activity as provided under Treas. Reg. § 1.72-17(f). Accordingly, the assessments for the 2008, 2009, and 2010 taxable years have been abated.

The Code of Virginia sections and public documents cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5422480600.o