May 4, 2021
Re: § 58.1-1821 Application: Individual Income Tax
Dear *****:
This will reply to your letter in which you request correction of the individual income tax assessment issued to ***** (the “Taxpayer”) for the taxable year ended December 31, 2017.
FACTS
The Taxpayer filed a Virginia resident income tax return for the 2017 taxable year claiming business and itemized deductions. Under audit, the Department requested information to support the claimed deductions. After reviewing the information provided by the Taxpayer, the Department disallowed Schedule A deductions for unreimbursed employee expenses and Schedule C deductions for expenses related to his self-employment as a ride-share driver and referee. The Department adjusted the return and issued an assessment. The Taxpayer appeals contending the information provided was sufficient to support the deductions claimed.
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 Virginia 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. 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.
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.
Unreimbursed Business Expenses – Schedule A
For the taxable year at issue IRC § 67, allows an individual to 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”. The Taxpayer claimed unreimbursed business expenses for travel expenses, lodging, and meals for his work as a business consultant.
Travel Expenses
The Taxpayer deducted automobile expenses for unreimbursed business travel on his Schedule A. 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. Travel costs incurred from home to the first job and from the last job to home, however, 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 (IRS) 463, Travel, Entertainment, Gift, and Car Expenses.
The Taxpayer has provided receipts from an oil change business that recorded the number of miles his vehicle traveled between oil changes. This record is not a daily record of the mileage traveled. It does not distinguish whether the mileage was for business consulting, refereeing, rideshare, commuting or personal use.
Lodging
Lodging expenses that are incurred while traveling away from home in the pursuit of business are generally deductible under IRC § 162(a). Pursuant to IRC § 274(d), however, a deduction for lodging expenses is disallowed when a taxpayer fails to substantiate (1) the amount of the expense, (2) the time and place of travel, and (3) the business purpose of the expense. The Taxpayer claimed unreimbursed business expenses for hotel stays. Such expenses must be substantiated through appropriate documentation. The only documentation provided for unreimbursed employee hotel expenses were notations of business consultant next to hotel charges on the Taxpayer’s bank statements.
Meal Expenses
A taxpayer may deduct reasonable and necessary expenses for meals incurred while away from home in the pursuit of a trade or business. See IRC § 162(a). The only documentation provided for unreimbursed employee meal expenses were notations of business consultant next to restaurant charges on the Taxpayer’s bank statements. Based on this documentation, the Department’s auditor disallowed meal expenses claimed on Schedule A as unreimbursed business expenses.
Ordinary and Necessary Business Expenses – Schedule C
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. The Taxpayer claimed ordinary and necessary business expenses for travel, lodging, meals and home office usage for his ride-sharing and refereeing businesses.
Travel Expenses
The Taxpayer deducted travel expenses as ordinary and necessary for his ride-share and refereeing businesses on his Schedule C. The expenses of operating and maintaining a car used for in the course of a business are deductible. As stated above, Taxpayers may use the actual operating costs or the business standard mileage rate in computing the deductible costs. Expenses must 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 receipts provided by the Taxpayer from an oil change business is not a daily record of the mileage traveled.
Lodging
Lodging expenses that are incurred while traveling for business are generally deductible under IRC 162(a). As stated above lodging expenses for business purposes must be substantiated pursuant to IRC 274(d). The Taxpayer claimed unreimbursed business expenses for hotel stays. The only documentation provided for unreimbursed employee hotel expenses were notations of business consultant next to hotel charges on the Taxpayer’s bank statements. None of the lodging expenses that were identified as refereeing or ride-share business were reported on Schedule C.
Meal 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 taxpayers’ trade or business if the taxpayers establish that they 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 substantiate business meals. Based on the documentation provided, the Department’s auditor disallowed meal expenses claimed on Schedule A as unreimbursed business expenses and on Schedule C for his ride-share business. The auditor allowed, however, a portion of the meals expense claimed on Schedule C for the Taxpayer’s refereeing business.
Home Office Expenses
The Taxpayer deducted insurance, rent, and utilities as home office expenses from the income reported for his ride-share and refereeing businesses on his Schedule C. Under IRC § 280A, expenses can be deducted for the business use of a residence 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 Comm. v. Soliman, 506 U.S. 168 (1993), the United States Supreme Court determined that an anesthesiologist who treated his patients at hospitals, but performed his administrative work at his residence, could not deduct home office expenses because his residence was not a principle place of business. The Court held that the principal place of business must be determined by comparing the relative importance of activities performed and time spent at each business location. As such, the hospitals where the anesthesiologist performed his medical services were the principal place of business because his home office was merely used for administration.
In this case, the most important part of the Taxpayer’s business as a ride-share driver occurred when he drove his vehicle, not in his residence. Likewise, the most important part of the Taxpayer’s business refereeing games, and the time spent at that activity occurred, at the venues where he refereed. In both cases, the Taxpayer may have used his residence for administrative functions, not as the principle activity.
Other Business Expenses
The auditor either disallowed or reduced the amount of the expenses deducted on the Schedule C for advertising, legal and professional services, office and supplies, commissions and bank fees to reflect the provided documentation. As stated above, all business expenses must be substantiated in order to be deductible. See Treas. Reg. § 1.6001-1. IRC § 274(d) requires that the taxpayer substantiate business expenses “by adequate records or by sufficient evidence corroborating his own statement.” The records must set forth the amount of the expense, the time and place of the travel, the business purpose of the expenditure, and the business relationship of the taxpayer to the expense incurred.
CONCLUSION
The Department’s auditor requested that the Taxpayer provide a detailed description of his job and supporting documentation such as mileage logs, receipts and canceled checks. Based on the documentation provided, the auditor disallowed all the claimed unreimbursed business expenses and expenses attributed to the ride-share business. Further, the auditor adjusted the reported expenses for travel, meals and office expense for the Taxpayer’s refereeing business. All other business expense deductions were disallowed.
Receipts showing the mileage traveled between oil changes and bank statements with individual transactions noted as business expenses do not sufficiently substantiate the claimed business expenses are required by the IRC and its related regulations. I will, however, allow the Taxpayer 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 Taxpayer 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 Taxpayer.
The Code of Virginia sections and public document 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/3613.B