Could a Virginia resident subtract all retirement distributions when deductible contributions had previously been taxed by Pennsylvania?

Plain-English summary

A Virginia resident subtracted all distributions from a retirement account for 2014 and 2015 because Pennsylvania had taxed his contributions. Virginia initially denied the subtraction.

Virginia later allowed a proportional subtraction, not the full distributions. Previously taxed contributions qualified, but account earnings did not.

The two-part eligibility test

Va. Code § 58.1-322(C)(19) applies only when contributions were both:

1. deductible in computing federal adjusted gross income; and
2. nevertheless subject to another state's income tax.

The taxpayer's Pennsylvania-taxed contributions met both conditions. Income earned inside the account did not qualify merely because it grew from those contributions.

How Virginia calculated the subtraction

Following P.D. 10-214, Virginia used a proportional method. It multiplied the year's taxable distributions by a fraction whose numerator was total previously taxed contributions and whose denominator was the year-end account value plus that year's distributions.

The Department returned the matter to audit to allow the calculated 2014 and 2015 subtractions and issue refunds if the revised calculations warranted them.

What this means for you

• Preserve proof that another state taxed your retirement contributions.
• Confirm the contributions were federally deductible.
• Do not assume the entire distribution qualifies; investment growth is excluded.
• Account balances and distribution records are needed for Virginia's proportional calculation.

Common questions

Q: Did Pennsylvania's treatment create a Virginia subtraction?

A: Yes, for the portion representing qualifying contributions previously taxed by Pennsylvania.

Q: Were earnings in the account subtractable?

A: No. The ruling expressly excludes income generated by the contributions.

Q: Were refunds automatic?

A: The case returned to audit to apply the allowed subtractions and issue refunds as warranted.

Citations and references

• Va. Code §§ 58.1-301, 58.1-322(C)(19) — conformity and subtraction
• Va. Code §§ 58.1-1821, 58.1-1824 — appeal and protective claim
• Related Virginia rulings cited: P.D. 10-214 and P.D. 15-104

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-36

Original ruling text

April 18, 2019

Re: § 58.1-1824 Application: Individual Income Tax

Dear Mr. *:

This will reply to your letter in which you seek a refund of income tax paid by * (the “Taxpayer”) for the taxable years ended December 31, 2014, and 2015.

FACTS

The Taxpayer filed Virginia resident individual income tax returns for the 2014 and 2015 taxable years and claimed subtractions for the entire amount of income he received from a retirement account. In each case, the Department notified the Taxpayer that it was denying the subtraction and issuing assessments. Before the assessments were issued, the Taxpayer paid the proposed amounts of additional tax and interest due. The Taxpayer subsequently appealed, contending the information he provided to the Department supports the subtractions because his contributions to the account were previously taxed by Pennsylvania.

DETERMINATION

Protective Claim

Pursuant to the authority granted the Department under Virginia Code § 58.1-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Virginia Code § 58.1-1821. As permitted by statute, the Taxpayer’s request has been treated as an appeal under Virginia Code § 58.1-1821.

Retirement Subtraction

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 Virginia 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 a retirement account may be eligible for the subtraction under Virginia 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 recognized that Pennsylvania does not allow contributions made by an employee to a retirement plan to be excluded from income. That determination also 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 Virginia 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).

The information provided indicates that the Taxpayer made contributions to a retirement account that were deductible for federal income tax purposes but subject to income tax in Pennsylvania. As such, the Taxpayer was eligible to subtract a portion of the taxable distributions he received from the account in 2014 and 2015. The Department has computed the allowable subtractions in accordance with the formula described in P.D. 10-214. Accordingly, the case will be returned to the audit staff to allow the subtractions in accordance with the enclosed schedule and issue refunds as warranted.

The Code of Virginia sections and public document 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 determination, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1733.M

Related Documents

10-214

15-104