March 13, 2020
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 assessments issued to ***** (the “Taxpayers”) for the taxable years ended December 31, 2016 and 2017.
FACTS
The Taxpayers, a husband and wife, filed Virginia resident income tax returns for the 2016 and 2017 taxable years claiming business and itemized deductions. Under audit, the Department requested information to support the claimed deductions. After reviewing the information provided by the Taxpayers, the Department disallowed Schedule A deductions for unreimbursed employee expenses and charitable gifts and Schedule C deductions for expenses related to the operation of two businesses. The Department adjusted the returns and issued assessments. The Taxpayers appeal, contending the information provided was sufficient to support the deductions claimed.
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 Virginia Code § 58.1-322.01 through § 58.1-322.04.
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 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 medical expenses, charitable contributions and business expenses provided they are claimed in accordance with the IRC and its related regulations.
Unreimbursed Employee 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. Unreimbursed employee expenses are considered expenses incurred in carrying on a trade or business and are reportable on federal Schedule A. Under IRC § 67, however, an individual may only deduct the expenses, along with certain other miscellaneous itemized deductions, to the extent they collectively exceed 2% of FAGI, commonly referred to as the “2% floor.”
Gifts to Charity
Under IRC § 170(a), taxpayer 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 acknowledgement 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 requirement established by federal regulations. For a donation of cash, check, or other monetary gifts regardless of the amount, a taxpayer must maintain a record of the contribution. Examples of acceptable documentation are bank records or written communication from the qualified organization.
Sole Proprietorship
As stated above, IRC § 162 permits taxpayers to deduct all of the ordinary and necessary business expenses paid or incurred during the taxable year in carrying on any trade or business. The expenses of a business that is carried on by the taxpayer are reportable on Schedule C and are not subject to the 2% floor for miscellaneous itemized deductions because such expenses are already deducted in the computation of FAGI. See IRC § 62(a)(1).
CONCLUSION
The Taxpayer’s assert they were eligible to claim itemized deductions and expenses incurred while conducting their sole proprietorships. The Taxpayers, however, must maintain records sufficient to allow the IRS to determine their correct 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 to properly 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.
In this case, the Department requested information to substantiate the deductions during both the audit and the appeal. The Taxpayers have failed to provide the requested information.
Pursuant to Virginia Code § 58.1-205 any assessment of tax by the Department is deemed prima facie correct. This means that the burden of proof is upon the Taxpayer to establish that the assessment is incorrect. 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.
I will, however, grant the Taxpayers one final opportunity to provide the information required to substantiate the deductions. The documentation must be provided within 30 days from the date of this letter. The Taxpayers must send the additional information to the Department’s Office of Tax Policy, Appeals and Rulings, P.O. Box Richmond, Virginia 23261-7203, Attention: *****. Once the documentation is received, it will be forwarded to the audit staff for review, and they will adjust the assessments as warranted and notify the Taxpayers of the results of the review. If the Taxpayers still disagree with the results, they may file an appeal within 90 days of the date they are notified. If the documentation is not submitted within the time allotted, the assessments will be considered to be correct and collections actions will resume.
Although taxpayers could claim unreimbursed employee expenses as a deduction during the taxable years at issue, taxpayers should be aware that the ability to claim such expenses as a deduction was suspended beginning in the 2018 taxable year by P.L. 115-97, commonly known as the “Tax Cuts and Jobs Act” (the TCJA), enacted in 2017. See IRC 67(g).
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
AR/2164.A