I know I calculated my Virginia subtraction for retirement income already taxed by another state wrong -- how is it actually supposed to be computed?

Plain-English summary

Virginia lets a taxpayer subtract retirement income from a qualified pension, profit-sharing or stock bonus plan (IRC § 401), an IRA (IRC § 408), a deferred compensation plan (IRC § 457), or a federal government retirement program -- but only the portion whose CONTRIBUTIONS met a two-part test: (1) the contributions were deductible for federal income tax purposes, and (2) despite that federal deduction, the contributions were still subject to income tax in another state (typically because that other state didn't allow the same deduction Virginia relied on). This ruling is a useful companion to the more common cases where the subtraction gets denied entirely for lack of proof -- here, a couple already agreed they were ELIGIBLE for the subtraction but had simply calculated the amount wrong, and the Department walked through how the calculation actually works.

Virginia uses two different approved computation methods depending on the type of account. For accounts whose balance fluctuates over time -- IRAs, and accounts under IRC § 401(k) or § 403(b) -- the Department applies a pro-rata approach from an earlier ruling (P.D. 10-214): you multiply your total distributions for the year by a ratio of your previously-taxed contribution balance divided by the sum of the account's year-end value plus the year's distributions. For periodic, determinable payments from a traditional pension plan, a simplified method applies instead (from P.D. 15-104, tracking a federal formula in IRC § 72(d)(1)(B)): divide your total previously-taxed contributions (as of the annuity's start date) by your expected number of monthly payments to get a fixed non-taxable amount per payment, then multiply that by the number of payments actually received during the year.

Applying this, the wife's pension turned out to qualify: her contributions had been deductible federally but were added back to her income in her prior home state, and she received her distributions in equal periodic payments -- a clean fit for the simplified method, which the Department computed and attached as a schedule. The husband's situation was murkier: it appeared his pension contributions were made with after-tax dollars, meaning they were never federally deductible in the first place -- and if that's the case, part of his distributions would already be excluded from federal income as a simple return of his own contributions, which means they wouldn't separately qualify for this subtraction (since the subtraction only applies to contributions that were both deducted federally AND taxed elsewhere). The couple also had various IRA, 401(k), 403(b), and 457 accounts beyond the pension, but without more detail -- which contributions went to which account, which accounts were still active in 2018, and whether any rollovers happened along the way -- the Department couldn't determine how much, if any, of those distributions qualified. Since taxpayers bear the burden of proving subtraction eligibility, the Department gave the couple 60 additional days to supply that missing detail, adjusting the assessment based on whatever was submitted (or, if nothing came in, based only on the wife's properly computed pension subtraction).

What this means for you

Taxpayers who know they qualify for the retirement-income subtraction but aren't sure how to calculate it

Use the pro-rata method for accounts with a fluctuating balance (IRAs, 401(k)s, 403(b)s): total distributions × (previously-taxed contribution balance ÷ (year-end account value + total distributions)). Use the simplified method for periodic, fixed pension payments: (previously-taxed contributions ÷ expected number of payments) × payments actually received this year.

Taxpayers whose retirement contributions were made with after-tax dollars

Check whether your contributions were actually deductible for federal purposes in the first place -- if they weren't (because they were after-tax), part of your distribution is likely already excluded from federal income as a return of your own contributions, and that portion doesn't separately qualify for Virginia's subtraction on top of that.

Taxpayers with multiple retirement accounts (pension plus IRAs, 401(k)s, 403(b)s, 457 plans) claiming this subtraction

Keep clear records tying each contribution to a specific account, tracking which accounts remain active, and documenting any rollovers -- without that detail, the Department can't verify how much of each account's distributions qualifies, and the burden is on you to provide it.

Common questions

Q: What two conditions do my retirement contributions need to meet to qualify for this Virginia subtraction?
A: The contributions must have been (1) deductible for federal income tax purposes, and (2) still subject to income tax in another state despite that federal deduction (this typically happens when the other state didn't conform to the same federal deduction Virginia does).

Q: Which computation method applies to my account?
A: For accounts with a changing balance (IRAs, 401(k)s, 403(b)s), use the pro-rata method from P.D. 10-214. For periodic, fixed pension payments, use the simplified method from P.D. 15-104, based on IRC § 72(d)(1)(B).

Q: What if my pension contributions were made with after-tax dollars?
A: Then they likely weren't deductible for federal income tax purposes in the first place, which means part of your distribution is already excluded from federal income as a return of your own contribution -- and that portion doesn't qualify for this subtraction, since the subtraction requires the contribution to have BEEN federally deductible.

Citations and references

• Va. Code § 58.1-301 (Virginia conformity to the IRC)
• Va. Code § 58.1-322.02(11) (subtraction for retirement distributions where contributions were federally deductible but taxed by another state)
• IRC § 401 (qualified pension, profit-sharing, and stock bonus plans)
• IRC § 408 (individual retirement accounts)
• IRC § 457 (deferred compensation plans)
• IRC § 72(d)(1)(B) (federal simplified method for the tax-free portion of pension payments)
• P.D. 10-214 (9/15/2010) (pro-rata computation method for IRAs, 401(k), and 403(b) accounts)
• P.D. 15-104 (5/12/2015) (simplified computation method for periodic pension payments)

Subject

Subtraction: Retirement income - Pensions, IRA, 401(k), 403(b), 457 Plans

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-128

Original ruling text

August 10, 2022

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 assessment issued to * and *** (the “Taxpayers”) for the taxable year ended December 31, 2018.

FACTS

The Taxpayers, a husband and wife, filed a Virginia resident individual income tax return and each claimed subtractions for pension and IRA contributions previously taxed by * (State A) for the taxable year ended December 31, 2018. Under audit, the Department denied the subtraction and issued an assessment for additional tax and interest. The Taxpayers paid the assessment and filed an appeal. The Taxpayers concede that they incorrectly calculated the subtractions, but they request that their assessment be adjusted to reflect the proper subtraction amounts.

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 .

Virginia Code § 58.1-322.02 11 (formerly 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.

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 Virginia Code § 58.1-322.02 11 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). This computation is appropriate for retirement accounts with changing account values such as individual retirement accounts (IRAs) or accounts established under IRC § 401(k) or § 403(b).

The Department has also 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. This computation is appropriate for individuals who receive periodic determinable periodic payments from traditional pension plans.

Based on the information provided, it appears that the wife made contributions to a pension plan that were deductible for federal income tax purposes but added back to her state taxable income when she resided in * (State A). For the taxable year at issue, she received distributions from the pension plan in equal periodic payments. As such, the wife qualified for the subtraction, as computed using the simplified method.

It appears that the husband’s pension contributions were made using after tax dollars and thus were not deductible for federal income tax purposes. If so, a portion of the husband’s pension distributions would already have been excluded from federal taxable income as a return of contribution, and thus, the distributions would not have been eligible for the subtraction.

The Taxpayers have also indicated that they made contributions to other plans such as those established under IRC §§ 401(k), 403(b) and 457 as well as IRAs. Although it appears that these contributions generally were deductible for federal income tax purposes and added back to their State A taxable income, it is unclear, for example, which contributions were made to which accounts, which accounts were active as of 2018, or whether and when any rollovers may have occurred. Without additional information to clarify the history and status of these accounts, the Department is unable to determine the extent the Taxpayers may have been eligible for the subtraction. Ultimately, taxpayers bear the burden of proving they are eligible for a subtraction.

A schedule showing what portion of the wife’s pension distributions was eligible for the subtraction is enclosed. The Department will allow sixty additional days for the Taxpayers to submit further information to establish their eligibility for the subtraction as to any distribution made from any of their other retirement accounts. Such information must be sent to *, Tax Examiner, Sr., Office of Compliance, Desk Audit, Office Audit Unit 3, P.O. Box 615, Richmond, Virginia 23218-0615. The information will be reviewed, the assessment will be adjusted as appropriate, and a refund will be issued accordingly. If the information is not received in the time allotted, the assessment will be adjusted to account for that portion of the wife’s pension distributions that was eligible for the deduction, but the assessment will otherwise be considered to be correct.

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 . If you have any questions regarding the information you must submit, you may contact at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3975.B

Related Documents

10-214

15-104