Can a Virginia resident subtract retirement account distributions from Virginia income tax because the money was earned while working in another state, or because contributions were made with after-tax dollars?

Plain-English summary

A husband and wife, Virginia residents, claimed subtractions on their 2018-2020 returns for distributions taken from the husband's retirement account. Under audit, the Department disallowed the subtractions and assessed additional tax. On appeal, the couple argued two things: first, that part of the account was funded while the husband worked and lived in other states, so that portion shouldn't be taxed by Virginia; second, that some contributions were made with after-tax dollars, so those distributions shouldn't be taxed again on the way out.

The Department rejected both arguments. On the residency point, it's well established (citing a 1937 U.S. Supreme Court case) that a state can tax all of a resident's income, even income earned outside the state -- and the federal law the couple may have had in mind, 4 U.S.C. § 114, actually protects the OPPOSITE situation: it stops a state from taxing retirement income paid to someone who ISN'T a resident or domiciliary there. Since the couple were actual Virginia residents receiving the distributions, that federal protection didn't apply, and Virginia's own prior rulings confirm residents are taxed on retirement income regardless of where it was earned. On the after-tax-contribution point, the couple simply didn't prove their claim -- the documentation that would show a nontaxable return of contributions (a 1099-R, or federal Form 8606 for IRA-type accounts) wasn't in the record, and taxpayers bear the burden of proving they qualify for any subtraction, deduction, or credit. The assessments were upheld in full.

What this means for you

Virginia residents with retirement income earned in other states before moving

Moving to Virginia (or working elsewhere earlier in your career) doesn't shield retirement distributions from Virginia tax once you're an actual resident receiving them. Federal law (4 U.S.C. § 114) only protects NONRESIDENTS from being taxed by a state where they don't live -- it does nothing for a current resident, regardless of where the money was originally earned.

Anyone claiming a subtraction for after-tax retirement contributions

Have the paperwork ready before you claim it. This ruling shows the Department (and, if it comes to that, a reviewing court) will look for the specific federal documentation -- 1099-R and Form 8606 -- that establishes a nontaxable return of after-tax contributions. A bare assertion that "some contributions were after-tax" isn't enough.

Accountants and tax professionals

Remember that Virginia subtractions, deductions, and credits are treated as a matter of legislative grace, not entitlement -- the burden is always on the taxpayer to substantiate them. When advising a client on a retirement-income subtraction claim, gather the federal substantiating forms up front rather than relying on the client's recollection of how contributions were made.

Common questions

Q: Does Virginia tax retirement income that was earned while I lived and worked in a different state?
A: Yes, if you're a Virginia resident when the retirement income is actually received -- a state can tax all of a resident's income regardless of where it was earned, and federal law (4 U.S.C. § 114) only protects nonresidents, not residents.

Q: Can I subtract retirement distributions that came from after-tax (nondeductible) contributions?
A: Only the specific portion properly documented as a return of after-tax contributions -- generally shown on federal Form 1099-R or Form 8606 -- can be excluded; without that documentation, the full distribution remains taxable.

Q: Who has to prove that a Virginia subtraction applies -- the Department or the taxpayer?
A: The taxpayer. Subtractions, deductions, and credits are a matter of legislative grace, and the taxpayer bears the burden of proving eligibility.

Q: What happens if I can't provide the documentation an auditor asks for to support a subtraction?
A: As in this ruling, the Department will disallow the subtraction and the assessment will be upheld absent adequate proof.

Citations and references

• 4 U.S.C. § 114 (federal bar on source-state taxation of nonresident retirement income)
• Va. Code § 58.1-322.02 (subtractions from federal adjusted gross income)
• Va. Code § 58.1-301 (Virginia conformity to Internal Revenue Code terminology)
• New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937) (a state may tax all income of its residents, including income earned outside the state)
• P.D. 02-118 (9/3/2002) (residents taxed on retirement income even if derived from out-of-state employment)
• P.D. 16-128 (6/22/2016) (same principle reaffirmed)
• Howell's Motor Freight, Inc. v. Virginia Department of Taxation, Cir. Ct. City of Roanoke, Law No. 82-0846 (10/27/1983) (tax preference items are a matter of legislative grace; taxpayer bears burden of proof)

Subject

Subtractions: Retirement Income - Earned While Working In Other States, After Tax Contributions

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-51

Original ruling text

May 3, 2023

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the individual income tax assessment issued to * (the “Taxpayers”) for the taxable years ended December 31, 2018, through December 31, 2020.

FACTS

The Taxpayers, a husband and wife, filed Virginia resident individual income tax returns for the 2018 through 2020 taxable years, claiming subtractions for distributions taken from retirement accounts. Under audit, the Department disallowed the subtractions and issued assessments. The Taxpayers appeal, contending that the husband’s contributions were made with after-tax dollars and that the part of the retirement account that was attributable to contributions he made while not a resident of Virginia is not subject to Virginia income tax.

DETERMINATION

Taxation of Virginia Residents

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 .

It is well established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In New York ex rel. Cohn v. Graves , 300 U.S. 308, 312-313, 57 S. Ct. 466, 467 (1937), the United States Supreme Court explained “[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized.”

The Taxpayers believe that a portion of the husband’s retirement distribution was not subject to tax in Virginia because he resided in other states when the income that was contributed to the retirement account was earned. Public Law (P.L.) 104-95, as codified at 4 U.S.C. § 114, prohibits a state from imposing an income tax on any retirement income received by an individual who is not a resident or domiciliary of that state. To the extent included in FAGI, retirement income received by an actual or domiciliary resident of Virginia would be included in the computation of Virginia taxable income. In Public Document (P.D.) 02-118 (9/3/2002), the Department determined that, under P.L. 104-95, retirement income received by an actual resident of Virginia was subject to Virginia’s income tax even if the retirement income was derived from employment in the other state and the taxpayer remained a domiciliary resident of the other state. See also P.D. 16-128 (6/22/2016).

Retirement Income Subtraction

Virginia Code § 58.1-322.02 provides for the subtraction from FAGI of certain items of income for purposes of determining VTI. These subtractions, however, are allowable only to the extent the income was included in FAGI. See id .

The Taxpayers contend that the contributions were made with after-tax dollars and, therefore, the distributions were not taxable. Based on the federal tax laws that existed at the time the husband made retirement contributions, it is possible that some of those contributions were not deductible for federal income tax purposes. If any of the contributions were made with after-tax dollars, then a portion of the distributions would have been excluded from federal taxable income as a return of contribution. To the extent any part of a distribution was so excluded, it would not have been eligible for a Virginia subtraction because it would have been excluded from FAGI. Subtracting them on the Virginia return would result in a double benefit because the same amount would be subtracted in determining FAGI and then again when determining VTI.

In addition, if the Taxpayers were eligible to exclude a portion of the distribution as a return of contribution, this would be evident from the Form 1099-R or the federal Form 8606 submitted with the federal income tax return for the year of distribution. Federal Form 8606 is used to report nondeductible (i.e., “after-tax”) individual retirement account (IRA) contributions and to calculate the portion of an IRA distribution that is treated as a recovery of such contributions in the taxable year. The documentation submitted by the Taxpayers did not contain any indication that the Taxpayers were entitled to a recovery of contributions.

Regardless, if a Virginia resident has retirement income included in FAGI, such income is only eligible for the subtraction to the extent it meets the requirements of Virginia Code § 58.1-322.02. Because tax preference items such as deductions, subtractions and credits are not afforded to taxpayers by right, but rather as a matter of legislative grace, taxpayers bear the burden of proving that they qualify to claim such items. 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). In this case, no evidence has been presented to show that the Taxpayers qualified for a subtraction of any portion of their retirement distributions.

CONCLUSION

Because the Taxpayers were residents of Virginia for the 2018 through 2020 taxable years, they were subject to tax on their entire Virginia taxable income. The husband’s retirement distributions were properly included in their Virginia taxable income and were not eligible for any subtraction. Based on the foregoing, the Taxpayers’ request for relief cannot be granted and the assessments are upheld. Updated bills will be issued shortly. The Taxpayers should remit payment of the balance due within 30 days of the bill dates to avoid the accrual of additional interest and possible collections actions.

The Taxpayers request information concerning further remedies beyond this appeal. The Taxpayers are referred to Title 23 of the Virginia Administrative Code (VAC) 10-20-165 F for information regarding a request for reconsideration of this decision and to Virginia Code § 58.1-1825 for information regarding an application for relief that may be filed with a Virginia circuit court. In addition, the Department considers offers-in-compromise (OICs) as to doubtful liability or collectibility on a case-by-case basis.

The Code of Virginia sections, regulation, 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/4186.X

Related Documents

02-118

10-214

16-128

22-30