Tax Type
Individual Income Tax
Description
Taxpayers unable to furnish sufficient information to substantiate their deductions
Topic
Appropriateness of Audit Methodology
Federal Conformity
Records/Returns/Payments
Date Issued
08-10-2012
August 10, 2012
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, 2007 through 2010.
FACTS
The Department adjusted the Taxpayers' business deductions reported on their 2007 through 2010 Virginia income tax returns and issued assessments. The Taxpayers appeal the assessments, contending the adjustments are not based on state license standards for in-home child care providers and do not properly reflect the expenses incurred for implementing such standards.
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). Income 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 Va. Code § 58.1-322.
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 FAGI 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.
Under IRC § 162, taxpayers are permitted to deduct all of the ordinary and necessary 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 and Dilts v. U.S., 845 F.Supp 1505 (1994).
The Taxpayers assert that the adjustments are not consistent with Virginia's child care licensing requirements. Further, in order to adhere to the child care standards, the Taxpayers were required to make upgrades to their residence and purchase additional child care equipment.
Under Treas. Reg. § 1.6001-1(a), taxpayers are required to maintain records sufficient to allow the IRS to determine their correct tax liability. In addition, Treas. Reg. §1.4461 (a) requires each taxpayer to maintain accounting records necessary to support entries on his return. Similarly, Va. Code § 58.1-310 provides:
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- 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.
The Taxpayers provided invoices, bank statements and a copy of the child care regulations to support the deductions claimed for the taxable years at issue. Because the business and non-business expenses were commingled, the Department has been unable to verify which expenses were directly related to the trade or business. As a result, the auditor computed the business deductions using industry average pricing methods established by the Internal Revenue Service. Because the Taxpayers have been unable to furnish sufficient information to substantiate their deductions, I must uphold the Department's assessments for the 2007 through 2010 taxable years.
An updated bill, with interest accrued to date, will be sent to the Taxpayers. No additional interest will accrue provided the outstanding balance is paid within 30 days from the date of the revised bill.
The Code of Virginia sections cited, along with other reference documents, are available on-line in the Tax Policy Library section of the Department's web site, located at www.tax.virginia.gov. If you have any questions regarding this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
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- Sincerely,
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- Craig M. Burns
Tax Commissioner
- Craig M. Burns
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AR/1-4979792718.D
Rulings of the Tax Commissioner