Could a Virginia resident subtract annuity-surrender gain because he borrowed the money before moving to Virginia and called it a death benefit?

Plain-English summary

Virginia taxed the annuity-surrender gain because it was recognized while the taxpayer was a Virginia resident and was not a death benefit. The taxpayer borrowed against the annuity while living in another state, moved to Virginia in 2007, and surrendered the contract without repaying the loan in August 2008.

Federal law generally treats amounts received before the insured's death—including loans and surrender proceeds—as income not received under an annuity. The taxpayer recognized the cash-surrender value, including the borrowed amount, only when the contract was surrendered, and the gain entered 2008 federal adjusted gross income.

Virginia's subtraction required a federally taxable lump-sum death-benefit payment awarded to the beneficiary under an annuity contract. This surrender gain did not meet those requirements, so the assessment remained due.

Common questions

Q: Did receiving the loan before moving to Virginia control the tax year?
A: No. The ruling treated the gain as recognized when the annuity was surrendered in 2008.

Q: Was the surrender gain a qualifying annuity death benefit?
A: No. It was not a lump-sum benefit awarded because of death.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322(C)(32).
• IRC § 72.
• Virginia Public Documents 09-36 (March 31, 2009) and 10-63 (May 7, 2010).

Subject

Surrendered annuity income at issue does not qualify for subtraction under Va. Code.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-109

Original ruling text

July 3, 2012

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 "Taxpayer") for the taxable year ended December 31, 2008.

FACTS

The Taxpayer was a resident of * (State A). While residing in State A, the Taxpayer borrowed money from an annuity of which he was the beneficiary. The Taxpayer moved into Virginia in June 2007. In August 2008, the Taxpayer surrendered the annuity without repaying the loan. As a result, the Taxpayer recognized a gain on the annuity income and the gain was included in his 2008 federal adjusted gross income (FAGI). The Taxpayer claimed a subtraction on the Virginia income tax return for the annuity death benefit payment.

Under audit, the Department disallowed the subtraction and issued an assessment. The Taxpayer appeals the assessment, contending the loan payment was received prior to moving into Virginia and the income should not be subject to Virginia's income tax.

DETERMINATION

Virginia Code § 58.1-301 provides that terminology and references used in Title 58.1 of the Code of Virginia will have the same meaning as provided in the Internal Revenues Code (IRC) unless a different meaning is clearly required. For individual income tax purposes, Virginia "conforms" to federal law, in that it starts the computation of Virginia taxable income with 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 Va. Code § 58.1-322.

Pursuant to Va. Code § 58.1-322 C 32, a taxpayer is allowed a subtraction for a death benefit payment received from an annuity contract. In order to qualify for the subtraction, the benefit payment must meet three requirements. First, the source of the payment. must be an annuity contract between a customer (the "Annuitant") and an insurance company. Second, the annuity payment must have been awarded to the beneficiary in a lump sum. Finally, the payment must be subject to taxation at the federal level. See Public Document (P.D.) 09-36 (3/31/2009) and P.D. 10-63 (5/7/2010).

Under IRC §72, proceeds received before the death of the insured e.g. , loan payments and amounts received on the surrender of an annuity contract, are generally treated as income "not received under an annuity". Thus, a transferee generally recognizes ordinary income in the amount received on the surrender of the contract.

In this instance, the Taxpayer surrendered the annuity during the 2008 taxable year. The Taxpayer was not required to recognize the cash surrender value of the annuity, which included the amount he borrowed, until he surrendered the contract. Because Virginia's income tax computation begins with FAGI, all income included in the FAGI of the Taxpayer as a Virginia resident in the 2008 taxable year is subject to Virginia's income tax unless a subtraction provided under the law is applicable.

Based on the information provided, the income at issue does not qualify for the subtraction provided under Va. Code § 58.1-322 C 32 or for any other subtraction. As such, the Department's adjustment is correct and the assessment remains due and payable. And updated bill will be issued shortly.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4915799388.D