Could a permanently disabled Virginia taxpayer subtract third-party sick pay reported as wages on Form W-2?

Subject

Third-party sick pay reported on Form W-2 did not qualify for the disability-income subtraction

Plain-English summary

Virginia denied a disability-income subtraction for third-party sick pay reported as wages on Form W-2. The taxpayer's physician said she was permanently and totally disabled, and the insurer said the benefits were fully taxable. But Virginia explained that qualification depended on the classification of the payments, not disability status alone.

The Virginia subtraction then allowed up to $20,000 of qualifying disability income defined by federal law. The Department distinguished qualifying plan payments from sick pay treated as wages and reported on Form W-2. Because the insurer issued a W-2, the payments were classified as temporary sick pay that did not qualify.

The Department upheld the 2006 assessment. It said a revised bill with interest would be issued and had to be paid within 30 days of the bill date to prevent additional interest.

What this means for you

• Permanent and total disability alone did not make every replacement-income payment eligible for the Virginia subtraction.
• How the payment is classified and reported for federal tax purposes mattered to the Department's analysis.
• Third-party sick pay reported as W-2 wages was treated as nonqualifying temporary sick pay in this ruling.
• Review the plan documents and tax forms before claiming a disability-income subtraction.

Common questions

Did Virginia dispute that the taxpayer was disabled?

No. The ruling accepted the physician's statement but said the payment classification controlled eligibility for the subtraction.

Why did the W-2 matter?

Virginia treated sick pay reported as wages on Form W-2 as temporary sick pay rather than the qualifying disability income described in the subtraction statute.

Was the assessment abated?

No. The request for abatement was denied.

Citations and references

• Va. Code § 58.1-322(C)(4)(b).
• IRC §§ 22(c)(2)(B)(iii) and 3402(o)(2)(C).
• Virginia Public Document 06-63.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-139

Original ruling text

July 14, 2010

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 2006 taxable year.

FACTS

The Taxpayers, a husband and wife, filed a Virginia individual income tax return for the 2006 taxable year and claimed a subtraction for disability income. The wife received a federal Wage and Tax Statement (Form W-2) reporting third-party sick pay. The Taxpayers subtracted this income as disability income on their 2006 Virginia return. The Department disallowed this subtraction and issued an assessment for additional tax, concluding that the third-party sick pay was not disability income subject to the subtraction. The Taxpayers appeal the assessment, contending that the income constitutes disability income because the wife is permanently disabled.

DETERMINATION

Virginia Code § 58.1-322 C 4 b provides a subtraction from federal adjusted gross income of up to $20,000 for certain disability income as defined under Internal Revenue Code (IRC) § 22(c)(2)(B)(iii). Disability income is defined under this section as the total amount paid under an employer's accident and health plan or pension plan that is included in an individual's gross income as wages or payments for time the employee is absent from work because of a permanent and total disability.

In Public Document (P.D. 06-63 (8/6/2006), the Department addressed the scope of the subtraction, concluding that disability income eligible for the Virginia subtraction is reported on the federal form for distributions from pensions, annuities, retirement or profit-sharing plans, IRAs, and insurance contracts (Form 1099-R). Sick pay (including third-party sick pay) reported as wages under IRC § 3402(o)(2)(C) and reported on Form W-2 does not qualify for the Virginia subtraction for disability income.

The wife provided a letter from her physician stating that she is permanently and totally disabled. A copy of a letter from the wife's insurer was also submitted, stating that the benefits were 100% taxable. The Taxpayers believed the income was taxable only for federal income tax purposes. The determination of whether income qualifies for the Virginia subtraction, however, is based on the classification of the income, not just whether an individual is disabled or not.

In this case, the insurer issued the Taxpayer a Form W-2 reporting wages. Such wages are considered temporary sick pay that does not qualify for the subtraction under Va. Code § 58.1-322 C 4 b. Accordingly, the Taxpayer's request for the abatement of the 2006 tax assessment must be denied. A revised bill, with interest accrued to date, will be sent to the Taxpayers. The outstanding balance must be paid within 30 days of the bill date to avoid the accrual of additional interest.

The Code of Virginia sections and public document cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Tax Policy Library section of the Department's web site. If your have any questions about this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Linda Foster

Deputy Tax Commissioner

AR/1-4244820831.D