Was a lump-sum nonqualified pension payment taxable by Virginia when a part-year resident received it after moving into the state?

Subject

Nonqualified pension received after move was Virginia income

Plain-English summary

Virginia upheld the 2010 assessment because the husband received the lump-sum nonqualified pension after becoming a Virginia resident. The couple argued that the payment represented deferred wages from employment in State A and should follow the source rules used for nonresidents and stock options.

That source analysis did not control because the husband was a Virginia resident when the distribution was received. Virginia starts a resident's taxable income with federal adjusted gross income and taxes a part-year resident on income received during the Virginia-resident portion of the year.

The distribution was included in federal adjusted gross income and no Virginia modification excluded it. The fact that it arose from earlier work in another state did not prevent Virginia from taxing it upon receipt by a resident.

The couple also could not claim an other-state credit because State A imposed no income tax. The ruling acknowledged that 4 U.S.C. § 114 did not apply to nonqualified plans, but held that Virginia taxation was proper under the resident receipt rule. This letter was the Department's final determination after P.D. 13-95.

What this means for you

• For part-year residents, the date a lump-sum payment is received can control Virginia attribution.
• Deferred compensation from out-of-state work can still be taxable when received as a Virginia resident.
• A Virginia other-state credit requires tax actually paid to the other state on qualifying income.
• Qualified and nonqualified retirement plans can raise different federal protections.

Citations and references

• Va. Code §§ 58.1-302, 58.1-303, 58.1-322, 58.1-325, and 58.1-332 A.
• 23 VAC 10-110-40 B.
• 4 U.S.C. § 114.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-79

Original ruling text

May 30, 2014

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek reconsideration of the Department's determination letter, issued as Public Document (P.D.) 13-95 (6/11/2013), to * (the "Taxpayers") for the taxable year ended December 31, 2010.

FACTS

In P.D. 13-95, the Department held that a lump sum nonqualified pension distribution from a nonqualified retirement plan was income attributable to Virginia because it was received during the portion of the year in which the Taxpayers, a husband and a wife, had become, residents of Virginia. The Taxpayers seek a redetermination, contending the income should be attributed to * (State A).

DETERMINATION

The Taxpayers' argue that, for part-year residents, Va. Code § 58.1-325 requires a calculation of a ratio of income and deductions from Virginia sources to income and deductions from all sources. Under Va. Code § 58.1-302, "Income and deductions from Virginia sources" includes:

1. Items of income, gain, loss and deduction attributable to:

a. The ownership of any interest in real or tangible personal property in Virginia

b. A business, trade, profession or 'occupation carried on in Virginia; or

c. Prizes paid by the Virginia Lottery Department, and gambling winnings from wagers placed or paid at a location in Virginia.

Under the Taxpayers' rationale, the nonqualified pension distributions would not be income from Virginia sources because they were essentially deferred wages from

the husband's employment in * (State A). The Taxpayers further assert that the

income from nonqualified pension plans should be treated the same as nonqualified stock awards or options.

The Taxpayer asserts that the treatment of the lump sum nonqualified pension distribution should be similar to the Department's treatment of stock options. In P.D. 99 -­ 79 (4/20/1999), the Tax Commissioner ruled that the appreciation in the value of stock from the date of grant to the date of exercise is compensation from Virginia sources for services performed in Virginia by an employee who is granted incentive stock options ("ISOs"). If a taxpayer moves from Virginia after the date the ISOs were granted, the nonresident taxpayer is subject to Virginia income tax on the appreciation of the value of the stock. Further, the amount of a nonresident's Virginia source income with respect to ISOs granted in connection with Virginia employment is determined at the time the stock is sold and income or gain is recognized for federal purposes. See also P.D. 05-32 (3/15/2005).

Virginia Code § 58.1-325 addresses the taxation of individuals who are not residents of Virginia but have income from Virginia sources. If the husband were a nonresident of Virginia when the lump sum nonqualified pension distribution was received, the income would have been treated similarly to the Department's treatment of income from ISOs received by nonresident individuals. The husband, however, was a resident of Virginia when the Taxpayers received the distribution. Accordingly, the Taxpayers' analysis with regard to Va. Code § 58.1-325 is misplaced.

For individual income tax purposes, Virginia starts the computation of Virginia taxable income for residents with federal adjusted gross income (FAGI). See Va. Code § 58.1-322. Income 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. The lump sum nonqualified pension distribution was included in the Taxpayers' FAGI for the 2010 taxable year.

It has been 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, 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." See also Lawrence et al. v. State Tax Commission of State of Mississippi , 286 U.S. 276, 52 S.Ct. 556 (1932) and Shaffer v. Carter, State Auditor, et al. , 252 U.S. 37, 40 S.Ct. 221 (1920). Further, in Ryan v. Commonwealth of Virginia , 169 Va. 414, 423, 193 S.E. 534, 538 (1937), the Virginia Supreme Court (the "Court") determined that the Virginia income tax "is a tax levied upon Mrs. Ryan measured by the net income - received and enjoyed" in the Commonwealth. The Court upheld the assessment of income tax.

Pursuant to Va. Code § 58.1-303, part-year residents are subject to tax only on their income that is attributable to Virginia. Title 23 of the Virginia Administrative Code (VAC) 10-110-40 B specifically defines income attributable to Virginia as "that which is received during the portion of the year in which the individual is a Virginia resident; . . ." [Emphasis added.] Because the husband was a resident of Virginia at the time the lump sum nonqualified pension distribution was received, Virginia clearly has the authority to impose its income tax on all of the retirement income.

As indicated above, courts have long recognized that the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event. It is also a long established principle that the risk of double taxation does not violate a taxpayer's constitutional rights. In Guaranty Trust Co. of New York v. Commonwealth of Virginia , 305 U.S. 19, 59 S.Ct. 1 (1938), the United States Supreme Court held that the imposition of an income tax under Virginia laws on income received as beneficiary of trust established in New York did not violate the Due Process Clause of the Constitution, notwithstanding that the trust was also subject to tax in New York. Nor did such treatment deny equal protection under the United States Constitution.

The Commonwealth's method of averting the impact of "double taxation" is to allow an out-of-state tax credit. Virginia Code § 58.1-332 A allows Virginia residents a credit on their Virginia return for income taxes paid to another state, provided the income is either earned or business income or any gain on the sale of a capital asset. The credit is limited to the lesser of the amount of tax actually paid to the other state or the amount of Virginia income tax actually imposed on the taxpayer on the income earned or derived in the other state. See P.D. 97-301 (7/7/1997). In this case, the Taxpayers moved from a state that does not impose and income tax. As such, the Taxpayers would not be eligible for an out-of-state tax credit.

In P.D. 13-95, the Department recognized that under Title 4 U.S.C. § 114, a state is prohibited from imposing an income tax on any retirement income received by an individual who is not a resident or domiciliary of that state. The Taxpayers argue that Title 4 U.S.C. § 114 only applies to qualified retirement plans, not to nonqualified pension distributions. While Title 4 U.S.C. § 114 does not apply to nonqualified plans, the distribution was properly attributed to Virginia when received for the above stated reasons.

As indicated above, once the husband became a resident of Virginia, the Department had the authority to impose tax on all of his income, no matter what its source. Accordingly, the assessment of the 2010 taxable year is upheld. While I recognize the Taxpayers' continuing disagreement with the validity of the assessment, P.D. 13-95 and this letter clearly explain the Department's position. As such, this letter constitutes the Department's final determination with regard to the Taxpayers' assessment for the 2010 taxable year.

An updated bill, with interest accrued to date, will be mailed to the Taxpayers. No additional interest will accrue provided the outstanding assessment is paid within 30 days of the date of the bill. Please remit payment to: Virginia Department of Taxation, Attention: *, 600 E. Main Street, 23rd Floor, and Richmond, Virginia, 23219. If you have any questions concerning payment of the assessment, you may contact at **.

The Code of Virginia sections, regulation and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's web site. If you have any questions regarding this response, you may contact * in the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5469681246.B