I got severance and unused vacation pay from my Virginia employer when I separated, but part of my ten years of service was spent working out of state -- can I subtract that portion on my Virginia return?

Plain-English summary

A husband and wife living in Virginia in 2018 filed a joint resident return after the husband separated from his Virginia employer, receiving both severance pay and payment for unused vacation covering ten years of accredited service. On their return, they claimed a subtraction for a proportional share of that severance and vacation pay attributable to a period the husband had worked outside Virginia during those ten years -- originally framed as retirement income that had already been taxed by another state. The Department disallowed the subtraction, since the payments weren't actually retirement income at all, and issued an assessment. The taxpayers paid it and appealed, this time conceding they weren't eligible for a retirement-income subtraction but arguing they should still get relief because the underlying income was earned while the husband worked outside Virginia.

Federal law is clear that both severance pay and employer-provided vacation payouts are ordinary taxable income. Virginia generally follows federal law by starting its own tax computation with federal adjusted gross income, taxing everything in it unless a specific Virginia statute provides an exemption or subtraction. The Department noted its own prior rulings establishing that severance pay is Virginia-source income when paid by a Virginia employer -- typically the issue arises for a taxpayer who worked in Virginia but later became a nonresident before receiving the severance. Here, the reverse fact pattern applied: the husband was a Virginia resident receiving payments from a Virginia employer, but wanted to attribute part of that income to work performed elsewhere in earlier years. On unused vacation pay specifically, the Department pointed to a prior ruling (P.D. 97-337) that squarely rejected the same theory -- an individual couldn't subtract vacation-pay-outs attributable to work performed in a prior year in another state, because Virginia's tax code simply doesn't include a subtraction for compensation earned in another state in a previous year.

The Department also addressed the double-taxation concern directly: courts have long held that a state may tax income received by its own resident even if that same income is also taxed elsewhere, without violating due process or equal protection (citing a 1938 U.S. Supreme Court case upholding Virginia's taxation of trust income also taxed by New York). Because the severance and vacation payments were received by a Virginia resident from a Virginia employer, and Virginia's statutes don't provide any subtraction for either type of payment, the full amount remained taxable, and the previously-paid assessment stood with no refund.

What this means for you

Anyone receiving severance pay or an unused-vacation payout when leaving a Virginia employer

If you're a Virginia resident when you receive the payment, expect the full amount to be taxable by Virginia, even if part of your underlying service was performed while working in another state. Virginia has no subtraction that carves out an "attributable to out-of-state work" portion of severance or vacation pay.

Taxpayers concerned about double taxation on the same income by two states

Being taxed by Virginia on income that might also be taxable elsewhere doesn't violate your constitutional rights, and by itself isn't a basis for a Virginia subtraction -- you'd need Virginia's own credit-for-taxes-paid-to-another-state provision (which applies only if you actually owe and pay tax to that other state on that same income), not a unilateral subtraction.

Anyone trying to characterize ordinary compensation (severance, vacation payout) as "retirement income" to access a subtraction

That reframing won't work if the payment isn't actually a distribution from a qualifying retirement plan -- severance and vacation pay are ordinary wage-type income under federal tax regulations, regardless of how many years of service they're calculated from.

Common questions

Q: Can I subtract part of my severance pay if it's based on years I worked in a different state?
A: No -- Virginia doesn't provide any subtraction for severance pay, regardless of where the underlying work was performed, as long as you're a Virginia resident receiving it from a Virginia employer.

Q: What about unused vacation pay I'm cashed out for when I leave my job?
A: Same answer -- Virginia's tax code doesn't include a subtraction for vacation pay attributable to work performed in another state in a prior year; the full payout is taxable if you're a Virginia resident.

Q: Doesn't taxing this income violate my rights if another state could also tax the same income?
A: No -- courts have long upheld a state's authority to tax its own resident's income even when the same income might also be subject to tax elsewhere; that risk of double taxation doesn't violate due process or equal protection.

Citations and references

• Va. Code § 58.1-301 (Virginia income tax terminology/conformity to the Internal Revenue Code)
• Treas. Reg. § 1.61-2(a) (wages and termination pay are taxable income)
• Treas. Reg. § 1.61-21(a) (employer-provided vacation pay is taxable income)
• P.D. 97-123 (3/10/1997) and P.D. 10-37 (4/8/2010) (severance pay is Virginia-source income when paid by a Virginia employer)
• P.D. 97-337 (8/25/1997) (no Virginia subtraction for unused vacation pay attributable to work performed in another state in a prior year)
• P.D. 97-301 (7/7/1997) (cited as a related document on credit computation for taxes paid to another state)
• Guaranty Trust Co. of New York v. Commonwealth of Virginia, 305 U.S. 19 (1938) (a state may tax its resident's income even if the same income is also taxed by another state, without violating due process or equal protection)

Subject

Subtraction: Disallowed Out-of-State Severance and Vacation Pay

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-105

Original ruling text

June 1, 2022

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the assessment of individual income tax issued to * (the “Taxpayers”) for the taxable year ended December 31, 2018.

FACTS

During 2018, the Taxpayers, a husband and wife, were residing in Virginia when the husband separated from his Virginia employer. He received both severance pay and pay for unused vacation for ten years of accredited service. The Taxpayers filed a joint Virginia resident individual income tax return for the 2018 taxable year, claiming a subtraction for a proportional amount of the severance and vacation pay they attributed to a period of time the husband worked outside of Virginia during the ten year service period.

The Taxpayers claimed the subtraction as income derived from a retirement plan, the contributions to which had been taxed in another state. The Department disallowed the subtraction, and issued an assessment, on the basis that the income subtracted was not retirement income. The Taxpayers paid the assessment and appealed. The Taxpayers concede that they were not eligible for the retirement income subtraction, but they contend that the subtraction should be allowed because the income the subtraction was based on was earned when the husband was not a resident of Virginia.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, that the 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. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . For individual income tax purposes, Virginia “conforms” to federal law, in that it starts the computation of Virginia taxable income (VTI) with federal adjusted gross income (FAGI). Income properly 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 Chapter 3 of Title 58.1 of the Code of Virginia .

Treas. Reg. § 1.61-2(a) provides that wages and termination pay are income subject to taxation. In Public Document (P.D.) 97-123 (3/10/1997) and P.D. 10-37 (4/8/2010), the Department determined that severance pay is considered Virginia source income to a nonresident individual when paid by a Virginia employer. Typically, this situation arises when a taxpayer, who previously resided and worked in Virginia but later became a nonresident, had severance pay attributable to income from Virginia sources. Once again, the husband received severance payments from a Virginia employer, but claims that part of the payment should be attributable to work performed outside of Virginia.

Treas. Reg. § 1.61-21(a) provides that employer provided vacations constitute income subject to taxation. In P.D. 97-337 (8/25/1997), an individual subtracted payments she received for unused vacation time that accrued from her work in a prior year in another state. The subtraction was disallowed by the Department because the Code of Virginia did not provide a subtraction for compensation earned in another state in a previous year. Like the individual in P.D. 97-337, the Taxpayers in this case have subtract a proportional amount of unused vacation pay attributable to work performed in another state.

Courts have long recognized that the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event. It is also a long established principle that the risk of double taxation does not violate a taxpayer’s constitutional rights. In Guaranty Trust Co. of New York v. Commonwealth of Virginia , 305 U.S. 19 (1938), the United States Supreme Court held that the imposition of an income tax under Virginia laws on income received as beneficiary of a trust established in New York did not violate the Due Process Clause of the Constitution, notwithstanding that the trust was also subject to tax in New York. Nor did such treatment deny equal protection under the United States Constitution.

Here, the severance and vacation payments were received by a Virginia resident from a Virginia employer. Under these circumstances, all of the income, including the severance and vacation payments, reported in the Taxpayers’ FAGI would be subject to Virginia income tax unless specifically exempt pursuant to Virginia statutes. Because the Code of Virginia does not include a subtraction for either type of payment, the subtraction was properly disallowed.

The Department’s records indicate the assessment has been paid. Therefore, no further action is required.

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 determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/4025.B

Related Documents

97-123

97-301

97-337

10-37