Was a retirement-plan loan offset taxable by Virginia when employment ended before the move but the full distribution and offset occurred after becoming resident?

Plain-English summary

A taxpayer borrowed from a retirement account while living in Texas, ended employment in April 2015, moved to Virginia in May, and requested a full distribution in July. The plan used part of the account to repay the outstanding loan.

Virginia taxed the entire July distribution. The loan offset occurred when the account benefit was actually reduced, after Virginia residency began.

Timing rule

Part-year residents are taxed on income received during their Virginia-resident portion of the year. A plan-loan offset is an actual distribution when the plan reduces the participant's accrued benefit to repay the loan.

The employment termination created a repayment obligation, but the note allowed repayment before distribution. The offset occurred only with the later requested distribution.

What this means for you

• Separate employment termination from the date of an actual plan offset.
• Review the note and plan terms governing loan repayment.
• Part-year residence assigns income by when it is received.
• An offset can be taxable even when no cash for that portion reaches you.

Common questions

Q: Was the loan treated as distributed on the last workday?

A: No. The actual offset occurred with the July full-account distribution.

Q: Why did Virginia tax it?

A: The taxpayer was a Virginia resident when the distribution occurred.

Citations and references

• Va. Code §§ 58.1-301, 58.1-303 — conformity and part-year tax
• 23 VAC 10-110-40(B) — resident-period income
• Treas. Reg. § 1.402(c)-2, Q&A 9(b) — plan loan offset

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 19-20

Original ruling text

March 26, 2019

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, 2015.

FACTS

While the Taxpayer was a resident of Texas (State A), she borrowed money from a retirement account. The Taxpayer moved to Virginia in May 2015. In July 2015, the Taxpayer took a full distribution from the retirement account without repaying the loan. As a result, the distribution was offset by the remaining balance of the loan. Subsequently, the Taxpayer filed a Virginia part-year resident income tax return for the 2015 taxable year but did not include the distribution from the retirement account. Under audit, the Department determined the distribution was made during the Taxpayer’s period of Virginia residency and, thus, was subject to Virginia income tax. As a result, an assessment was issued. The Taxpayer believes the assessment is overstated and paid a portion of the assessment. She contends the portion of the distribution used to offset the loan balance should be attributable to her period of State A residency.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, 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. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia. 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 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 Virginia Code § 58.1-322.

Virginia Code § 58.1-303 provides that a taxpayer who becomes a resident of Virginia during the taxable year is subject to taxation for the period in which they were a Virginia resident. Accordingly, Virginia taxable income is computed by determining income, deductions, subtractions, additions and modifications attributable to the period of residence in Virginia. In addition, part-year residents may claim a portion of their Virginia personal exemptions, but the exemptions will be prorated based upon the number of days that the taxpayer was a Virginia resident. Further, part-year residents may claim a prorated Virginia standard deduction if they claim the standard deduction for federal income tax purposes.

Pursuant to Virginia 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.”

The Taxpayer asserts that the remaining loan balance was deemed a distribution on the last day of her employment, April 30, 2015, and thus occurred during her period of State A residency. The Taxpayer’s promissory note provides that if her employment were to terminate for any reason, that she must pay the loan off in full before taking the distribution or have the outstanding loan balance deducted from the distribution. The information provided indicates that the Taxpayer requested a distribution of the full vested account balance in July 2015 and that the remaining loan balance was deducted from the distribution.

Treas. Reg. § 1.402(c)-2, Answer 9(b) explains that “a distribution of a plan loan offset amount is a distribution that occurs when, under the plan terms governing a plan loan, the participant’s accrued benefit is reduced (offset) in order to repay the loan . . . .” A distribution of a plan loan offset amount is considered an actual distribution, not a deemed distribution under IRC § 72(p). In this case, the Taxpayer’s offset occurred upon the distribution of the full vested account value pursuant to her July 2015 request. By that time, the Taxpayer was already a Virginia resident. Because the distribution was received during the portion of the year in which the Taxpayer was a Virginia resident, the Department’s adjustment to the Taxpayer’s 2015 return was correct.

Based on the foregoing, the assessment for the unpaid balance is upheld. An updated bill will be issued shortly. The Taxpayer should remit payment for the outstanding balance as shown on the revised bill within 30 days from the date of the revised bill to avoid the accrual of additional interest.

The Code of Virginia sections and regulation cited 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 regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

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