I took a distribution from a 403(b) retirement account, and my contributions to it were taxed by another state when I made them -- can I subtract the ENTIRE distribution from my Virginia income, or only part of it?

Plain-English summary

This ruling is a taxpayer loss that walks through exactly how Virginia calculates a specific and often-misunderstood tax break: the subtraction meant to prevent double taxation of retirement contributions that were already taxed by another state.

Virginia lets a taxpayer subtract retirement plan income from Virginia taxable income, but only to the extent the underlying contributions were (1) deductible for federal income tax purposes when made, and (2) actually subject to income tax in another state at the time. A husband made contributions to a 403(b) retirement plan (a tax-sheltered annuity plan for public schools and certain nonprofits) while working in another state whose law taxed those contributions when made. When the couple later took a distribution from that account, they subtracted the ENTIRE distribution on their Virginia return, arguing that was the only way to avoid double taxation.

The Department disagreed, applying the pro-rata methodology it established in a 2010 ruling: you divide the previously-taxed contribution balance by the account's total value (contributions plus accumulated investment gains) to figure out what fraction of any distribution represents a return of those already-taxed contributions -- only that fraction is exempt. The rest of the distribution -- representing investment gains earned inside the account over the years -- was never taxed by the other state in the first place, so subtracting it from Virginia income wouldn't be preventing double taxation; it would just be exempting income that was never taxed anywhere until now. The couple argued their 403(b) should be treated like a Roth IRA (which allows qualified distributions tax-free) and pointed to older Department guidance they said allowed a full subtraction, but the Department found those older documents either predated the current statute, addressed a different issue, or involved taxpayers who hadn't made a taxable contribution to another state at all. Because the pro-rata formula has gone unchanged and consistently applied for over a decade without the legislature stepping in to change it (a doctrine called "legislative acquiescence"), the Department found its methodology reasonable and upheld the assessment.

What this means for you

Anyone who worked in multiple states and is now taking retirement distributions

If some of your retirement contributions were taxed by another state when you made them, don't assume you can subtract your ENTIRE distribution from Virginia income. Only the portion that represents a return of those specific previously-taxed contributions is exempt -- investment gains accumulated over time remain fully taxable by Virginia, even though they came out of the same account.

Anyone comparing their retirement account to a Roth IRA

A 403(b), traditional pension, or similar plan funded with contributions that were taxed by another state is not treated the same as a Roth IRA for this Virginia subtraction, even if you think the practical effect should be similar. The pro-rata formula applies regardless of how you'd prefer to characterize the account.

Accountants and tax professionals calculating this subtraction for clients

Use the ratio from P.D. 10-214: previously-taxed contribution balance divided by the sum of the account's year-end value plus the year's distributions, applied against the total distribution amount. Watch for clients citing older public documents (pre-1996 or otherwise factually distinguishable) as support for a full subtraction -- this ruling walks through why several commonly-cited older documents don't actually support that position.

Common questions

Q: I took a distribution from a retirement account whose contributions were taxed by another state -- can I subtract the whole thing from my Virginia income?
A: No. Only the portion that represents a return of the previously-taxed contributions is exempt, calculated using a pro-rata ratio. Investment gains earned inside the account are still taxable by Virginia.

Q: Why doesn't Virginia just exempt the whole distribution to avoid double taxation?
A: Because only the original contributions were actually taxed by the other state -- the investment gains that built up over time were never taxed anywhere until the distribution, so exempting them wouldn't be preventing double taxation; it would just be a windfall exemption.

Q: Can I treat my 403(b) or pension like a Roth IRA for this subtraction?
A: No. The Department has rejected that comparison; the pro-rata formula applies to retirement plans funded with contributions that were taxed elsewhere, regardless of how similar the account might seem to a Roth IRA in practice.

Citations and references

• Va. Code § 58.1-322.02 11 (formerly § 58.1-322 C 19) (subtraction for retirement plan income, limited to contributions both federally deductible and previously taxed by another state)
• Va. Code § 58.1-301 (Virginia conforms to IRC terminology/references unless a different meaning is clearly required)
• 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) (subtractions strictly construed against the taxpayer)
• Peyton v. Williams, 206 Va. 595 (1965); Webster Brick Co., Inc. v. Dep't of Taxation, 219 Va. 81 (1978); Winchester TV Cable v. State Tax Comm'r, 216 Va. 286 (1975) (legislative acquiescence in a long-standing agency interpretation)
• P.D. 10-214 (9/15/2010) (established the pro-rata calculation methodology); P.D. 15-104 (5/12/2015), P.D. 17-91 (6/9/2017), P.D. 19-36 (4/18/2019) (consistent later application); P.D. 96-188 (8/5/1996), P.D. 96-217 (9/3/1996), P.D. 98-44 (3/9/1998), P.D. 04-177 (10/6/2004), P.D. 09-79 (5/26/2009) (older documents distinguished as inapplicable to this issue)

Subject

Subtraction : Retirement Income - Calculation

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-30

Original ruling text

February 15, 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 * (the “Taxpayers”) for the taxable year ended December 31, 2017.

FACTS

The Taxpayers, a husband and wife, filed a Virginia resident individual income tax return for the 2017 taxable year and claimed a subtraction for the entire distribution taken from a retirement account owned by the husband. Under audit, the Department adjusted the subtraction and issued an assessment for additional tax and interest. The Taxpayers appeal, contending the information they provided to the Department supports the full subtraction because the husband’s contributions to the account were previously taxed by * (State A).

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 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.

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.

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 a taxpayer to prove he is entitled to a subtraction reported on a Virginia return.

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).

The husband made contributions to an IRC § 403(b) plan while working in State A that were deductible for federal income tax purposes but subject to income tax in State A. The Taxpayers contend that the intent of the retirement income subtraction is to avoid double taxation. They assert that the Department’s methodology of calculating the subtraction in P.D. 10-214 is erroneous because it taxes contributions that were taxed by State A. The Taxpayers argue that the Department should treat an IRC § 403(b) plan the same as a Roth IRA. They also argue that public documents issued by the Department prior to P.D. 10-214 addressing the subtraction allowed the subtraction of the entire distribution amount.

An IRC § 403(b) plan (also called a tax-sheltered annuity or TSA plan) is a retirement plan offered by public schools and certain IRC § 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers can also contribute to employees’ accounts. State A law provided that contributions made by an employee to a retirement benefits plan, including a deferred compensation plan under IRC § 403(b), were taxable at the time the contributions are made.

Contributions to a Roth IRA are includable in a taxpayer’s FAGI and thus subject to both federal and Virginia tax. See IRC § 408A(c)(1). Pursuant to IRC § 408A(d), qualifying distributions from a Roth IRA are not includable in a taxpayer’s federal gross income. A qualified distribution is a distribution which is made under one of the following conditions: on or after the date the taxpayer reaches the age of 59½; to a beneficiary or estate on or after the taxpayer’s death; because of the taxpayer’s disability; or for a qualified special purchase, such as a first home.

The Taxpayers contend that the Department’s policy prior to the issuance of P.D. 10-214 allowed for the subtraction of the entire distribution of retirement income that was deducted for federal purposes, but taxed by another state. The retirement income subtraction became effective for taxable years beginning on and after January 1, 1996. Two public documents cited by the Taxpayers, P.D. 96-188 (8/5/1996) and P.D. 96-217 (9/3/1996), address taxable years before 1996. As such, they are not applicable. Although the Department informed the taxpayers of the recent law change in those public documents, the statements were provided for informational purposes only and were not interpretations of law as a matter of policy. Another document, P.D. 98-44 (3/9/1998) addressed certain issues with Roth IRAs, not the subtraction. The other documents cited by the Taxpayer addressing taxable years after 1996, P.D. 04-177 (10/6/2004) and P.D. 09-79 (5/26/2009), are not applicable because the taxpayers in those cases had not made a taxable contribution to the other state, so they were not eligible for the subtraction.

The applicable federal and Virginia statutes and regulations have remained unchanged in all relevant ways since the publication of P.D. 10-214. In Peyton v. Williams , 206 Va. 595, 600, 145 S.E.2d 147, 151 (1965), the Virginia Supreme Court (the “Court”) stated:

The elementary rule of statutory interpretation is that the construction accorded a statute by public officials charged with its administration and enforcement is entitled to be given weight by the court. The legislature is presumed to be cognizant of such construction. When it has long continued without change the legislature will be presumed to have acquiesced therein.

Similarly, the Court has consistently held that the construction of a tax statute by a state official charged with its administration is entitled to great weight. See Webster Brick Co., Inc. v. Dep’t of Taxation , 219 Va. 81, 245 S.E.2d 252 (1978) and Winchester TV Cable v. State Tax Comm’r , 216 Va. 286, 217 S.E.2d 885 (1975). A number of years have passed since the Department published P.D. 10-214. A lack of action by the General Assembly, especially over such a period, evinces legislative acquiescence in the Departments interpretation. Since then, the Department has consistently applied the methodology described in P.D. 10-214 and similar return of contribution computations in administering the retirement subtraction. See, e.g., P.D. 15-104 (5/12/2015), 17-91 (6/9/2017), and 19-36 (4/18/2019).

Further, the entire distribution does not have to be subtracted in order for taxpayers who qualify to be protected from double taxation. That is because it would only have been their contributions that were subject to tax in the other state. Investment gains over time within the account would not have been subject to state taxation. Once distributions from such an account are taken, only a part of the distribution would represent a return of contribution. The rest of the distribution would consist of investment gains. The methodology implemented by the Department to compute the subtraction ensures the portion of the distribution that represents previously taxed contributions is not subjected to state tax again. The rest of the distribution was not previously subject to state income tax would not be subject to double taxed by Virginia.

The Department’s methodology for calculating the retirement subtraction in P.D. 10-214 is a reasonable way to accurately reflect the portion of distributions that would be a return of a contribution rather than income generated from the retirement plan’s investments. Accordingly, the Taxpayers’ request for relief cannot be granted.

The case will be returned to the audit staff to adjust the assessment in accordance with the attached schedule and issue a revised bill. The Taxpayers should pay the bill within 30 days to avoid the accrual of additional interest and possible collections actions.

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 Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3763.B

Related Documents

96-188

96-217

98-44

04-177

09-79

10-214

15-104

17-91

19-36