December 13, 2024
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, 2020.
FACTS
The Taxpayers, a husband and wife, filed a joint resident individual income tax return for the 2020 taxable year. Under review, the Department requested information to support the business expense deductions reported on the Taxpayers’ federal Schedule C. After no response was received, the Department denied the deductions and issued an assessment. The Taxpayers disputed the assessment on the basis that the Internal Revenue Service (IRS) had already adjusted their 2020 federal income tax return. Additional documentation was requested by the Department, and the Taxpayers provided a copy of their IRS transcript for the 2020 taxable year. The Department adjusted the assessment to match the federal adjusted gross income (FAGI) reported on the transcript, but a balance remained due. The Taxpayers applied for correction, contending that the IRS has already adjusted their return.
DETERMINATION
Virginia Code § 58.1-301 provides, with certain exceptions, that the 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 (VTI) with the 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. 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. The Department has consistently exercised this authority in conducting its audit programs. See Public Document (P.D.) 10-126 (7/7/2010), P.D. 12-141 (8/29/2012), P.D. 14-155 (8/28/2014), P.D. 16-53 (4/11/2016), P.D. 19-104 (9/18/2019), and P.D. 21-67 (5/25/2021).
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 Taxpayers claimed ordinary and necessary business expenses on Schedule Cs filed with their 2020 federal income tax return. The Department requested that the Taxpayers provide documentation to substantiate these business expenses. When the documentation was not received, the deduction for the expenses was disallowed. The Taxpayers have provided no further documentation with their application for correction to substantiate the claimed expenses.
The Taxpayers argue that the Department’s assessment is invalid because the IRS already audited their 2020 federal income tax return and made the necessary adjustments. A review of the IRS transcript provided by the Taxpayers indicates that the IRS also disallowed the Taxpayers’ claimed deductions for business expenses. The IRS audit, therefore, actually supports the findings of the Department’s audit.
As stated above, the income or loss from a business is reflected in the FAGI reported on the federal income tax return. FAGI, in turn, is used as the starting point for the computation of VTI on the Virginia return. Any adjustment made by the IRS to a taxpayer’s FAGI must also be reflected in the FAGI used to determine the taxpayer’s Virginia income tax liability. In fact, Virginia Code § 58.1-311 requires any individual to report a change or correction in federal taxable income within one year of the final determination of such change or correction by filing an amended return with the Department. If the taxpayer fails to file an amended return, Virginia Code § 58.1-312 A 3 permits the Department to assess the appropriate tax at any time.
In this case, the audit staff ensured that the FAGI reported on the federal transcript matched the FAGI used to compute the assessment at issue. Accordingly, the assessment is upheld. The Taxpayers will receive an updated bill with accrued interest to date. The bill should be paid within 30 days of the bill date to avoid the accrual of additional interest.
The Code of Virginia sections cited are available online at law.lis.virginia.gov. The public documents cited are available at 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 and Legal Affairs, Tax Adjudication and Resolution Division, at ***** or *****.
Sincerely,
James J. Alex
Tax Commissioner
Commonwealth of Virginia
AR/4649.Y