Did a taxable lump-sum death payment qualify for Virginia's annuity death-benefit subtraction when it came from a § 403(b) retirement plan?

Subject

While the payments were issued by an insurance company, the documentation provided clearly shows the distributions were made from a retirement plan established under Internal Revenue Code (IRC) § 403(b).

Plain-English summary

Virginia denied the death-benefit subtraction because the payment came from a § 403(b) retirement plan, not a qualifying annuity contract. The taxpayer received the amount from an insurance company as a taxable lump sum, but those two facts did not satisfy the statute by themselves.

The ruling described three requirements: 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.

The taxpayer's documents showed a retirement-plan distribution. Virginia said the subtraction was intended for certain life-insurance-company annuity death benefits and was never intended to cover retirement-plan payments, even when the beneficiary chose a lump sum instead of periodic payments.

What this means for you

• Identify the legal source of a death payment, not merely the company issuing the check.
• A taxable lump sum is not enough if the payment comes from a retirement plan.
• Keep the annuity contract, plan documents, beneficiary statement, distribution form, and federal tax reporting.
• Distinguish a commercial annuity death benefit from a § 403(b) or other retirement-plan distribution.

Common questions

Q: Why did insurer payment not qualify?

A: The insurer was paying from a § 403(b) retirement plan rather than a qualifying annuity contract.

Q: Did taking a lump sum change the result?

A: No. A retirement-plan payment remained outside the subtraction even as a lump sum.

Q: Was the payment federally taxable?

A: Yes, but the ruling required all three statutory conditions, including the proper annuity-contract source.

Citations and references

• Va. Code §§ 58.1-301 and 58.1-322(C)(32).
• IRC § 403(b); Chapter 305, Acts of Assembly (2012).
• P.D. 09-36, P.D. 10-63, P.D. 12-76, and P.D. 14-112.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-48

Original ruling text

April 3, 2015

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the Virginia 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 claimed a subtraction for death benefit payments received from an insurance company for the 2010 taxable year. Under review, the Department disallowed the subtraction and issued an assessment on the basis that the payment was received from a pension plan. The Taxpayer appeals the assessment, contending the payment is a death benefit received in a lump sum, and subject to federal income tax. The Taxpayer believes she is eligible to claim the subtraction.

DETERMINATION

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), P.D. 12-76 (5/9/2012) and P.D. 14-112 (7/17/2014).

The Taxpayer argues she received a lump sum from an annuity contract issued by an insurance company. While the payments were issued by an insurance company, the documentation provided clearly shows the distributions were made from a retirement plan established under Internal Revenue Code (IRC) § 403(b).

Under the Department's interpretation and subsequent clarifying legislation, Chapter 305, Acts of Assembly (2012), the death benefit subtraction was never intended to be permitted for payments from a retirement plan. The intent of the subtraction was to equalize treatment of certain death benefit payments resulting from contracts with life insurance companies for Virginia income tax purposes. In addition, the subtraction applies only to death benefit payments subject to federal income tax. Because the payment was made pursuant to a retirement plan the Taxpayer could not have qualified for the subtraction, even if the Taxpayer accepted a lump sum in lieu of periodic payments. As such, the Department's assessment is upheld. An updated bill will be issued to the Taxpayer shortly.

The Code of Virginia sections, 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 ruling, you may contact * in the Office of Tax Policy, Appeals and Rulings, at****.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5671234006.D