April 11, 2016
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you seek correction of the Department's adjustments made to the Virginia individual income tax return filed by ***** (the "Taxpayers"), for the taxable year ended December 31, 2014.
FACTS
The Taxpayers, a husband and wife, resided in Virginia during the 2014 taxable year. The Taxpayers jointly owned a limited liability trucking company (VLLC) that was operated by the husband. On the Taxpayers' income tax return, the husband claimed a deduction for unreimbursed business expenses for mileage driven using the business standard mileage rate. In addition, the wife was employed as a sales agent for an unrelated business. She claimed an unreimbursed business expense deduction for mileage driven using the business standard mileage rate and deductions for home office expenses, 50% of the costs of meals and entertainment, and other miscellaneous business expenses. In addition, the Taxpayers filed a 2014 Virginia resident income tax return, claiming itemized deductions for medical expenses and for charitable contributions.
Under review, the Department disallowed the Taxpayers' medical and charitable donation deductions and adjusted both the husband and wife's unreimbursed business expense deductions, resulting in an assessment of additional tax. The Taxpayers appeal the adjustments, contending that all the deductions claimed were reported in the same manner as they had on their previous returns.
DETERMINATION
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). See Va. Code § 58.1-322 A.
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. However, the Department 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 Va. Code § 58.1-219.
Virginia Code § 58.1-322 D 1 a 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 medical expenses, charitable contributions and business expenses provided they are claimed in accordance with the IRC and its related regulations.
Medical Expenses
For taxable year 2014, IRC § 213 allows as a deduction the expenses paid for medical care of a taxpayer, his spouse, or a dependent to the extent that such expenses exceed 10% of FAGI. The auditor disallowed certain medical expenses because the Taxpayer had not submitted sufficient documentation of payment or expenses. The adjustment reduced the total amount of expenses below the 10% floor, eliminating the deduction.
Documentation
Treas. Reg. § 1.213-1(h) requires taxpayers to substantiate medical expenses, by providing a statement or itemized invoice from the individual or entity providing the service showing the type of service performed or item purchased, the patient the service was performed on, and the amount and date of payment. The Taxpayers have provided copies of receipts from a medical provider, a list of prescription claims and balances from their insurance company, bank statements, and the front of canceled checks. The receipts and the prescription list are acceptable forms of substantiation because they show the date the medication was purchased, the patient's name, the cost, and the provider. The bank statements and copies of the check fronts are not acceptable because they do not show the name of the patient, the service performed or the items purchased.
Insurance Premiums
The auditor disallowed the deduction of medical insurance premiums withheld by the wife's employer and life insurance premiums paid by the taxpayers. Payments for medical insurance premiums may be deducted only if the payments were made with money that was included in the taxpayer's gross income. See Adams v. Commissioner, Tax Court Memo. 2013-92. A review of the wife's W-2 indicates that her medical insurance premiums, including the amount paid by the wife out of pocket, were deducted from her pre-tax compensation. As such, the medical insurance premiums were not included in the wife's gross income and are not deductible. Life insurance premiums are considered personal expenses and are not deductible. See Charles W. Jamieson, PH TCM P 49261.
Gifts to Charity
Under IRC § 170(a), taxpayers may deduct charitable contributions of cash, tangible and intangible personal property, and services made during the taxable year. Treas. Reg. § 1.170A-13(a) generally requires contributions of money to be substantiated by cancelled check, receipt, or other reliable written records; however, for any charitable contribution of $250 or more, the taxpayer must have a contemporaneous written acknowledgment as described in Treas. Reg. § 1.170A-13(f) from the donee organization. Because of Virginia's conformity to the IRC, taxpayers must meet the substantiation requirements established by federal regulations.
The auditor disallowed monetary gifts the Taxpayers made to their church because they were not properly substantiated. Under Treas. Reg. § 1.170A-13 (a)(1)(ii), a taxpayer who makes a charitable contribution of money may substantiate his donation with a receipt from the donee organization showing the name of the donee, the date of the contribution, and the amount of the contribution. In this case, the Taxpayers have provided a receipt from their church acknowledging their annual contribution for the year at issue. As such, the Taxpayers have provided sufficient proof of their donation to a charitable organization.
Business 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. Under IRC § 67, an individual may only deduct the unreimbursed business expenses, along with certain other miscellaneous itemized deductions, to the extent that they collectively exceed 2% of FAGI, commonly referred to as the "2% floor".
Wife's Home Office Expenses
The wife was employed as a sales agent who worked out of a home office. She has provided documentation that her employer did not reimburse any business expenses she incurred. Under IRC § 280A, expenses can be deducted for the business use of a residence as an employee if the space is used exclusively and regularly as a principal place of business and the usage is at the convenience of the employer. Expenses that benefit both the residential and business use of the home are required to be allocated and only the portion attributable to the business may be deducted. Expenses directly attributable to the business need not be allocated. Expenses which in no way benefit the business are not deductible.
In this case, the auditor disallowed the allocated expenses for repairs, exterminator, residential phone line, rent and household insurance because they were personal living expenses. The allocated expenses for repairs, exterminator, rent, and household insurance are all deductible home office expenses provided they are substantiated. Residential phone usage would be deductible only for business related calls. Documentation would need to be provided by the wife to show specifically when the residential phone was used solely for business purposes.
Wife's Travel Expenses
The wife used the business standard mileage rate in computing her deductible automobile expenses. The auditor disallowed the business expense deduction because a detailed driving log was not provided.
The expenses of operating and maintaining a car used for business purposes are deductible. Taxpayers may use the actual operating costs or the business standard mileage rate in computing the deductible costs. See Rev. Proc. 2010-51 (12/3/2010). In PLR 8023052 (3/12/1980), the Internal Revenue Service (IRS) determined an individual working several jobs in the same locality may deduct the transportation expenses incurred in traveling between jobs. However, travel costs incurred from home to the first job and from the last job to home are generally nondeductible commuting expenses.
Expenses may be substantiated through the preparation of a daily diary or record of expenditures, maintained in sufficient detail to enable a taxpayer to readily identify the amount and nature of any expenditure, and the preservation of supporting documents, especially in connection with large or exceptional expenditures. See Treas. Reg. § 1.162-17 (d)(2). The methodology for business expense record keeping is more fully described in Internal Revenue Service Publication 463, Travel, Entertainment, Gift, and Car Expenses.
The Taxpayers have provided a schedule of the wife's weekly travel itinerary with the daily mileage driven. However, the itinerary does not distinguish which, if any, mileage occurred between the Taxpayer's home and the first and last appointments.
Wife's Meal Expenses
The auditor disallowed the meal expenses claimed by the Taxpayers because they did not provide adequate documentation of the expenses. Meals, which qualify as a business expense, are deductible up to 50% of their cost. See IRC § 274 (n)(1). An expenditure must be directly related to the conduct of the taxpayer's trade or business or associated with the active conduct of the taxpayer's trade or business. See IRC § 274(a)(1)(A). An expenditure is considered associated with the active conduct of the taxpayer's trade or business if the taxpayer establishes that she had a clear business purpose in making the expenditure, such as to obtain new business or to encourage the continuation of an existing business relationship. See Treas. Reg. § 1.274-2(d)(2). Individuals on business cannot deduct meal expenses for meals consumed while alone.
Treas. Reg. § 1.274-5A requires documentary evidence to substantial business meals. The Taxpayers have not provided a copy of all the meal receipts for meals claimed by the wife as meal expenses.
Wife's Other Business Expenses
The auditor either disallowed or reduced the amount of the expenses deducted for the wife's cell phone, office supplies, postage and insurance to reflect the receipts provided by the Taxpayers. As stated above, all business expenses must be substantiated in order to be deductible. See IRC § 274.
Husband's Business Expenses
The husband claimed a deduction for unreimbursed employee business expenses for meals, labor and vehicle mileage. Partners in a partnership (including members of a limited liability company) are considered to be self employed, not employees when performing services for the partnership. See Renkmeyer, Campbell and Weaver, LLP, et. al. v. Commissioner, 136 TC 137 (2011). The husband was a member of, and worked on behalf of VLLC. As such, he would not have been considered to be an employee of VLLC.
Generally, expenses that arise out of the operation of a partnership or limited liability company belong to the entity. See IRC § 703. A pass-through entity must report its income and expenses on an aggregate basis, which then flow through to the partner or member. An individual cannot make expenses belonging to a pass-through entity into their own by simply paying for it personally. See Ronnie 0. Craft, et ux. v. Commissioner, TC Memo 2005-197. As such, the mileage, meals and labor expenses incurred should have been deducted by VLLC, not the Taxpayers personally.
CONCLUSION
Based on the evidence provided, medical expenses substantiated by actual receipts are deductible provided the total amount exceeds 10% of the Taxpayers' FAGI. In addition, the contributions to the Taxpayers' church are deductible.
The wife's medical insurance premiums and the Taxpayers' life insurance premiums are not deductible. Also, the husband's unreimbursed business expenses are also not deductible.
The wife's home office, travel and meals expenses, and all of her other business expenses are only deductible to the extent they exceed the 2% floor. These expenses have not been substantiated. Under the provisions of Va. Code § 58.1-205, 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 Taxpayer to show the assessment is incorrect.
The case will be remanded back to the auditor to be adjusted pursuant to this determination. As stated above, some adjustments were made because the Taxpayers did not provide sufficient substantiation in accordance with the IRC and its related regulations. However, I will allow the Taxpayers an opportunity to provide adequate documentation of the deductions that were disallowed or adjusted. Such evidence must be sent to the auditor, ***** within 30 days of the date of this letter. ***** can be reached at *****. The Taxpayers will need to contact the auditor for instructions on providing the proper documentation required to substantiate their deductions. If the evidence is not received within the allotted time, an updated bill with accrued interest will be issued to the Taxpayers.
The Code of Virginia sections 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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AR/1-6151436375.B