Deduction: Itemized - Inadequate Documentation
March 1, 2023
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 ended December 31, 2018.
FACTS
The Taxpayers filed a Virginia resident income tax return for the 2018 taxable year, claiming charitable contributions as itemized deductions reportable on federal Schedule A and business expense deductions on federal Schedule C. Under audit, the Department requested documentation to support the deductions. When no response was received, the Department disallowed the deductions and issued assessments.
The Taxpayers appeal the assessment, contending they provided sufficient documentation. With their appeal, the Taxpayers submitted copies of their 2018 federal Schedules A and C, including federal Forms 8283 used to report noncash charitable contributions.
DETERMINATION
Conformity
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 Chapter 3 of Title 58.1 of the Code of Virginia.
As a general rule, the Department relies on the accuracy of information and computations reflected on the federal income tax return when reviewing Virginia individual income tax returns. If the information provided on the federal return looks reasonable, there is generally no reason to look behind those computations. The Department, however, retains the authority to adjust the FAGI and itemized deductions where there is clear evidence that the amounts reported on the federal or Virginia income tax return are not consistent with the IRC. See Virginia Code § 58.1-219.
Itemized Deductions
Virginia Code § 58.1-322.03 1 allows an individual to deduct from their Virginia adjusted gross income certain amounts allowed for itemized deductions for federal income tax purposes. These deductions include those for real estate taxes, home mortgage interest, personal property taxes, medical expenses, and charitable contributions, provided they are claimed in accordance with the IRC and its related regulations.
The auditor requested that the Taxpayers provide documentation supporting the charitable contribution deduction claimed on their 2018 Schedule A. The request clearly indicated the documentation required to substantiate the deduction. Deductions for charitable contributions are allowable only when they can be substantiated through items such as receipts or cancelled checks. See Public Document (P.D.) 14-155 (8/28/2014) and P.D. 19-78 (7/29/2019).
Under IRS regulations, substantiation requirements for gifts of property other than money vary depending on the amount of the deduction claimed. The regulations set up three tiers of deductions, for amounts up to and including $500, greater than $500 but less than $5,000, and greater than $5,000, and require greater substantiation for each tier. See Treas. Reg. § 1.170A-13. For purposes of determining the applicable threshold values, property and all similar items of property donated to one or more donees are treated as one property. See IRC § 170(f)(11)(F).
Under Treas. Reg. § 1.170A-13(b)(1), for items valued below $500, a taxpayer need only have a receipt from the donee containing the name and address of the donee, the date and place of the contribution, and a reasonably detailed description of the property donated.
Treas. Reg. § 1.170A-13(b)(3) provides that in addition to the receipt required by Treas. Reg. § 1.170A-13(b)(1), the donation of non-cash property with a value between $500 and $5,000 necessitates a written record of the manner and approximate date of acquisition and the cost basis.
Under Treas. Reg. § 1.170A-13(c)(2), if a taxpayer claims a deduction for a property valued in excess of $5,000, the taxpayer generally must obtain a qualified appraisal and attach an appraisal summary to their return.
The Taxpayers claimed deductions for donations of clothing, lawn furniture, equipment, and office equipment. With the exception of the clothing, it is unclear which thresholds applied, although it is possible based on how the property categories were reported on the Forms 8283 that the other categories also exceeded the $5,000 threshold after applying the aggregation rule of IRC § 170(f)(4)(5). In any event, the Taxpayers provided no additional information regarding their charitable contribution deductions with their appeal other than copies of their federal schedules. While the date of acquisition and cost basis for the donations were listed on the federal Forms 8283, no receipts were provided, which is the minimum requirement for any noncash charitable contribution. Further, no appraisals were submitted, and at a minimum, the deduction for clothing claimed by the Taxpayers far exceeded $5,000.
Schedule C Expenses
Under IRC § 162, taxpayers are permitted to deduct all of the ordinary and necessary business expenses paid or incurred during the taxable year in carrying on any trade or business. Such expenses must be directly connected with or pertaining to the taxpayer’s trade or business. See Treas. Reg. § 1.162-1.
Schedule C is used to report income or loss from a business, including a sole proprietorship. Income from the business is offset by expenses. This income or loss is reported on a taxpayer’s federal income tax return and thus is reflected in FAGI reported on the Virginia return.
The auditor requested that the Taxpayers provide documentation supporting the expenses claimed on Schedule C for the 2018 taxable year. The request clearly indicated the documentation required to substantiate each type of expense.
To substantiate car and truck expenses, the auditor requested, among other things, a mileage log. A mileage log show the dates, times and locations of travel as well as the business purpose and mileage. A mileage log or similar documentation is required to properly allocate miles driven between personal and business use. See IRC § 274(d) and IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses. The Taxpayers, however, did not submit any mileage logs. The Taxpayers did not submit any documentation other than their federal Schedule C and a statement that business use was less than 40%.
CONCLUSION
Taxpayers must maintain records sufficient to allow the IRS to determine their correct tax liability. See Treas. Reg. § 1.6001-1(a). Similarly, Virginia Code § 58.1-310 provides:
Whenever in the opinion of the Department it is necessary to examine the federal income returns or any copy thereof of any individual, estate, trust, partnership or corporation in order properly to audit such returns, the Department or the commissioner of the revenue shall have the right to require such taxpayer to provide such return or a copy thereof and all statements, inventories, and schedules in support thereof.
Under the provisions of Virginia Code § 58.1-205, in any proceeding relating to the interpretation of the tax laws of Virginia, an “assessment of a tax by the Department shall be deemed prima facie correct.” As such, the burden of proof is on the Taxpayers to show that the assessment was erroneous. In this case, the Taxpayer did not provide any substantiation for the deductions other than the federal schedules on which the deductions were reported.
In addition to the request for information made by the auditor, two additional requests for information were made while the appeal was under review, one by email on September 29, 2022, and then by letter dated November 1, 2022. To date, the Department has not received the information requested. Further, Virginia Code § 58.1-1826 precludes a court from granting relief to taxpayers seeking correction of erroneous state tax assessments in cases in which the erroneous assessment is attributable to the taxpayer’s willful failure or refusal to provide the Department with necessary information as required by law.
Sufficient documentation has not been provided by the Taxpayers to support the deductions claimed for charitable contributions and business expenses. Accordingly, there is no basis to abate the Department’s assessment for the 2018 taxable year. I will, however, give the Taxpayers one last opportunity to provide adequate documentation. The documentation should be submitted within 30 days from the date of this letter to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23161-7203, Attention: *****. Upon receipt, the documentation will be reviewed and the assessments may be adjusted, as appropriate. If the documentation is not received within the allotted time, the assessments will be considered correct.
The Code of Virginia sections and public documents cited are available online at www.tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. 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
AR/4328.X