Could a retiree use Virginia's simplified pension method without records proving that prior contributions were taxed by another state?

Subject

Calculating the portion of a retirement plan distribution attributable to previously taxed income

Plain-English summary

A retired federal employee claimed a Virginia subtraction for pension contributions he said had been taxed by other states between 1957 and 1990. He had received retirement payments for more than 30 years and could provide only Form 1099-R, not records showing which contributions had been added back and taxed on prior state returns.

Virginia explained two calculation methods. Its standard pro-rata method compared total previously taxed contributions with the retirement account's year-end value plus annual distributions. When year-end value was unavailable, the federal simplified method could divide the investment in the contract by a prescribed number of anticipated monthly payments.

Neither method eliminated the threshold proof requirement. The taxpayer first had to show that the contributions were federally deductible but taxed by another state. Because he supplied no evidence of those state add-backs, Virginia denied the subtraction and upheld the paid assessments for 2013 through 2015.

What this means for you

• Keep state returns and contribution records for retirement amounts taxed before distribution.
• The subtraction applies to qualifying contributions, not investment income generated by them.
• A simplified calculation method does not replace proof that another state taxed the contributions.
• Form 1099-R by itself generally identifies distributions, not the historical state tax treatment of contributions.

Citations and references

• Va. Code §§ 58.1-301, 58.1-322, and 58.1-322 C 19.
• IRC §§ 401, 408, 457, and 72(d)(1)(B).
• P.D. 10-214 and P.D. 15-104.
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Law No. 82-0846 (Roanoke City Cir. Ct. Oct. 27, 1983).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-134

Original ruling text

July 19, 2017

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond 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, 2013 through 2015. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer filed Virginia resident individual income tax returns and claimed a subtraction for pension contributions previously taxed by another state. Under audit, the Department denied the subtraction and issued assessments for additional tax and interest for each taxable year. The Taxpayer paid the assessments under protest then filed an appeal, contending he has received retirement income for a period exceeding thirty years and does not have access to the documentation requested by the Department. The Taxpayer requests an alternative means to show he is entitled to the subtraction.

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 19 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 IRC § 401, an individual retirement account or annuity established under IRC § 408, a deferred compensation plan as defined by IRC § 457, 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. Before taxpayers are permitted to subtract any portion of their retirement income, contributions to the retirement plan must satisfy a two-part test: (1) they must have been deductible for federal income tax purposes; and (2) they must still have been subject to income tax in another state. While the contributions made to the deferred compensation plan may be eligible for the subtraction under Va. Code § 58.1-322 C 19, income generated by those contributions are not.

In Public Document (P.D.) 10-214 (9/15/2010), the Department established a pro-rata approach that accurately reflects the nature of a distribution from a retirement plan. Accordingly, a taxpayer who receives a distribution from a retirement plan as described in Va. Code § 58.1-322 C 19 and whose contributions to such plan were subject to income taxation in another state would determine the portion of the annual distribution(s) eligible for the subtraction by multiplying the total amount of the annual distribution(s) by a ratio equal to the total balance of previously taxed contributions divided by the sum of the value of the retirement account at the end of the taxable year plus the total amount of the annual distribution(s).

In cases where the year end value of the pension fund is not available, the Department has ruled that a simplified method may be used. See P.D. 15-104 (5/12/2015). Under IRC § 72(d)(1)(B), a simplified method for determining the tax-free portion of pension payments has been established. Under the simplified method, the investment in the contract as of the annuity starting date (the total contributions previously taxed) is divided by a designated number of anticipated monthly payments to determine a monthly non-taxable payment. Assuming annuity payments are made monthly, the non-taxable payment is multiplied by the number of months an annuitant receives payments during the taxable year to determine excludable retirement income.

The complexity of calculating the portion of a retirement plan distribution attributable to previously taxed income was recognized by the Department and communicated to the General Assembly when enacted by House Bill 875 (Chapter 624, Acts of Assembly ) in 1996. In its Fiscal Impact Statement (FIS), the Department explained that it is generally difficult, if not impossible, to determine what portion of a distribution would be a return of a contribution or income generated from the investments because deferred compensation plan accounts can include multiple investment vehicles in which income is usually reinvested to and from funds which can be moved depending on the objectives of the owner of the account. Also, it is possible that an individual may have lived in several different states, and made retirement plan contributions under both conformity and nonconformity rules.

The Taxpayer contends that he began making contributions to his retirement account in 1957 and continued through 1990 as an employee of the federal government. He resided in a number of states, including one that does not impose an individual income tax. Because state tax statutes can change, it may be difficult to determine if the contributions met the statutory requirements during the years the Taxpayer lived in each state. The only documentation of the contributions provided was Form 1099R. By letter dated October 18, 2016 the Department requested additional documentation to support the Taxpayer's claim. The Taxpayer, however, provided no evidence that the contributions were added back for state income tax purposes. Instead, the Taxpayer asserts that it has been 60 years since the contributions were made and no additional documentation is available.

If the Taxpayer qualifies for the simplified method, he may be entitled to claim a subtraction on the tax free portion of the pension payments for up to 30 years under IRC § 72(d)(1)(B). The Taxpayer contends he retired in 1990, as such; he would be entitled to the subtraction until the 2020 taxable year. Absent of proof that the contributions were added back to his state income tax returns, no subtraction may be allowed.

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). As such, it is incumbent upon the Taxpayer to prove he is entitled to a subtraction reported on a Virginia return. Based on the information provided, the Taxpayer's request for relief is denied and the assessments are upheld. Because the assessments have been paid in full, no further action is required.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/824.D