To solve the issue, exclude the disk that contains the VHD file

Symptoms

1. You have a VHD file that contains an operating system and is booted from it;
2. The VHD file is located on the physical drive that is the host operating system;
3. You attempt to run a backup that contains the VHD drive and the physical drive of the host.
4. This fails with this error:

The specified volume is nested too deeply to participate in the VSS operation

Cause

Backup of a disk containing VHD file from which a computer is currently booted is not possible.

Solution

Exclude the disk that contains the VHD file from which the computer is currently booted.