Could insurance-company disability pension income qualify for Virginia's disability subtraction even when reported on Form W-2?

Subject

Taxpayers were eligible for the disability subtraction for the income reported by the insurance company on the W-2 Forms

Plain-English summary

A married couple claimed Virginia's disability-income subtraction for 2013 through 2015. Audit staff treated part of the insurance-company payments as third-party sick pay because they appeared on Forms W-2 and reduced the subtraction.

The couple supplied an insurer statement explaining that the payments were no longer salary continuation in lieu of wages but disability pension income. They also showed that the husband remained disabled under Social Security Administration standards.

Virginia concluded that further analysis could overcome the usual W-2 classification. The payments qualified for the disability subtraction, and the assessments were returned for adjustment, refunds, or revised assessments as warranted.

What this means for you

• Form W-2 reporting does not automatically make a disability payment ineligible.
• Obtain an insurer statement identifying whether payments are sick pay, salary continuation, or disability pension income.
• Document permanent and total disability status.
• Virginia's subtraction was limited to the amount and requirements stated in the cited law.

Citations and references

• Va. Code §§ 58.1-301, 58.1-322, and 58.1-322 C 4 b.
• IRC §§ 22(c)(2)(B)(iii), 22(e)(3), 72, 105(a), and 3402(o)(2)(C).
• P.D. 06-63, P.D. 10-139, and P.D. 16-209.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 17-107

Original ruling text

June 21, 2017

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessment issued to * (the “Taxpayers”) for the taxable year ending December 31, 2013 through 2015. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayers, a husband and wife, filed a Virginia individual income tax return and claimed a subtraction for disability income for the 2013 through 2015 taxable years. Under audit, a portion of the income included in the disability subtractions was treated as third party sick pay. Based on this finding, the Department reduced the allowable subtraction and issued assessments. The Taxpayers filed an appeal, contending the husband was disabled and the income treated as sick pay should be reclassified as disability income.

DETERMINAITON

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 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 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.

Virginia Code § 58.1-322 C 4 b provides an individual income tax subtraction for up to $20,000 of disability income as defined under Internal IRC § 22(c)(2)(B)(iii). This IRC section provides a federal income tax credit for a portion of disability income as defined under IRC § 72 or §105(a) to the extent such income constitutes wages, or payments in lieu of wages, for the period of time during which an individual is absent from work due to permanent and total disability.

Under IRC § 22(e)(3), an individual is “permanently and totally disabled” if they are “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.” Individuals claiming to be disabled may be required to provide proof of such disability to the IRS in order to show they are still eligible for the federal credit.

In Public Document (P.D.) 06-63 (8/6/2006) and P.D. 10-139 (7/14/2010), the Department addressed the scope of the subtraction. In these documents, the Department concluded that disability income eligible for the Virginia subtraction is generally 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, on the other hand, does not typically qualify for the Virginia subtraction for disability income. In P.D. 16-209 (12/8/2016), the Department further clarified its policy by pronouncing that addition analysis as to the classification of the income may be required when disability income is reported on a Form W-2.

In this case, the Taxpayers provided a statement from the insurance company affirming the husband's income was no longer classified as salary continuance payments in lieu of wages, but disability pension income. The documentation also shows the husband was still classified as disabled under Social Security Administration standards.

Thus, because the husband was disabled during the taxable years at issue, the Taxpayers were eligible for the disability subtraction for the income reported by the insurance company on the 2013 through 2015 W-2 Forms. The assessments will be returned to the auditor to be adjusted in accordance with this determination. Once the adjustments are made, either refunds or revised assessments will be issued with applicable interest.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/866.D