Did a federally taxable annuity death benefit qualify for Virginia's subtraction when the payment came from a retirement plan?

Subject

Retirement-plan annuity payment did not qualify for death-benefit subtraction

Plain-English summary

The taxpayer could not subtract the death-benefit annuity payment because it came from a retirement plan. Virginia upheld the 2010 assessment even though the payment was federally taxable and identified as an annuity on Form 1099-R.

The ruling describes three requirements for the subtraction: the payment must come from an annuity contract between a customer and an insurance company, be awarded to the beneficiary in a lump sum, and be subject to federal income tax. Merely calling a payment an annuity is not enough.

The Department interpreted the subtraction as relief for certain taxable death benefits tied to insurance-company contracts, not retirement-plan distributions. The taxpayer therefore would not have qualified even if she had accepted a lump sum instead of periodic payments.

The taxpayer argued that a 2012 amendment was being applied retroactively. The Commissioner answered that the legislation codified the Department's interpretation of the existing statute rather than creating a new rule for 2010.

What this means for you

• The source of a death-benefit payment matters as much as its tax form or annuity label.
• A federally taxable retirement-plan death benefit is not automatically eligible for this Virginia subtraction.
• The ruling required an insurance-company annuity contract and lump-sum beneficiary payment in addition to federal taxability.
• The Department treated the 2012 legislation as clarification of existing law.

Common questions

Q: Was federal taxability enough to qualify?

A: No. The payment also had to meet the contract-source and lump-sum requirements described in the ruling.

Q: Would choosing a lump sum have changed this taxpayer's result?

A: No. The Commissioner said the retirement-plan source independently prevented qualification.

Q: What happened to the assessment?

A: It was upheld, and no further action was required because the taxpayer had already paid it.

Citations and references

• Va. Code §§ 58.1-1821, 58.1-301, and 58.1-322 C 32.
• IRC §§ 101 and 72.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-26

Original ruling text

February 24, 2015

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, 2010. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer filed a 2010 Virginia income tax return and claimed a subtraction for death benefit payments received during the taxable year. Under audit, the Department disallowed the subtraction and issued assessments for additional tax and interest. The Taxpayer appeals the assessment, contending the payments received were from an annuity, resulting from death benefits as indicated on the Federal Form 1099R. The Taxpayer argues that the audit was based on statutory amendments, effective 2012 that should not be applied to prior taxable years.

DETERMINATION

Death Benefit Subtraction

Virginia Code § 58.1-301 provides 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. For individual income tax purposes, Virginia conforms to federal law in that it starts the computation of Virginia taxable income with the federal adjusted gross income (FAGI). 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.

Pursuant to Va. Code § 58.1-322 C 32, a taxpayer is allowed a subtraction of the death benefit payments from an annuity contract that is received by a beneficiary of such contract and is subject to federal income taxation. In order to qualify for the subtraction, a death benefit payment must meet three requirements. First, the source of the payment must be an annuity contract between a customer 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), P.D. 10-63 (5/7/2010), and P.D. 12-76 (5/9/2012).

Under IRC § 101, life insurance benefit payments paid by reason of the death of the insured are exempt from federal taxation, and thus exempt from Virginia taxation. IRC § 72, however, provides that a portion of the death benefits from an annuity, including life insurance contracts, are taxable. Because death benefits were treated dissimilarly for income tax purposes, the Virginia General Assembly sought to provide relief to individuals who are unable to obtain standard life insurance. As a result, the death benefits subtraction for lump sum payments from annuity contracts issued by insurance companies was enacted. See P.D. 13-149 (7/31/2013).

The Taxpayer argues that the subtraction is derived from a death benefit paid to her as an annuity and was subject to federal income tax. As indicated above, however, meeting the definition of an annuity is not the only requirement for the subtraction. Under the Department's interpretation and subsequent clarifying legislation, the death benefit subtraction was never intended to be permitted for payments from a retirement plan. The intent of the death benefit subtraction was to equalize treatment of certain death benefit payments resulting from contracts with life insurance companies for Virginia income tax purposes. The subtraction applies to death benefit payments subject to federal income tax. In this case, because the annuity payment was made pursuant to a retirement plan, the Taxpayer could not have qualified for the subtraction, even if she accepted a lump sum in lieu of periodic payments.

Interpretation of Statute

The Taxpayer contends that the Department cannot retroactively apply the statute as amended in 2012. The 2012 legislation (Chapter 305, Acts of Assembly ) was enacted to codify the Department's interpretation of the existing statute. See P.D. 13-149 (7/31/2013).

CONCLUSION

Based on the foregoing, the Department's assessment for the 2010 taxable year is upheld. Because the Taxpayer previously satisfied the assessment, no further action is required.

The Code of Virginia sections and public documents 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 about this determination, please contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5564914782.D