December 13, 2024
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will respond to your letter in which you seek a refund of individual income tax paid by ***** (the “Taxpayer”) for the taxable year ended December 31, 2023.
FACTS
The Taxpayer filed a Virginia resident individual income tax return for the 2023 taxable year and claimed a subtraction for the entire amount of income he received as a distribution from a retirement account. The Department notified the Taxpayer that it had denied the subtraction and adjusted the return. The Taxpayer paid the additional tax due and filed an application for correction, contending his contributions to the retirement account were previously taxed by State A.
DETERMINATION
Conformity
Virginia Code § 58.1-301 provides, with certain exceptions, 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. 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.
Retirement Income Subtraction
Virginia Code § 58.1-322.02 11 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 entitlement to a subtraction reported on a Virginia return.
In Public Document (P.D.) 10-214 (9/15/2010), the Department recognized that State A 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 § 58.1-322.02 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). In this case, the retirement account at issue was a thrift savings plan (TSP) with a changing account value.
The information provided supports the Taxpayer’s claim that he made contributions to a retirement account that were deductible for federal income tax purposes and subject to income tax in State A. As such, the Taxpayer was eligible to subtract a portion of the taxable distribution that he received from the account in 2023. The Department has computed the allowable subtraction in accordance with the formula described in P.D. 10-214. Accordingly, the Department will allow the subtraction in accordance with the enclosed schedule and issue a refund as warranted.
The Code of Virginia sections cited are available online at law.lis.virginia.gov. The public document cited is available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact ***** in the Office of Tax Policy and Legal Affairs, Tax Adjudication and Resolution Division, at (***) ***** or *****@tax.virginia.gov.
Sincerely,
James J. Alex
Tax Commissioner
Commonwealth of Virginia