Did stacks of statements, education records, and mileage logs substantiate a taxpayer's deductions without a reconciliation to the return?

Subject

Unreconciled expense documents did not substantiate claimed deductions

Plain-English summary

Virginia could not allow the taxpayer's 2006 through 2008 deductions because the records were not connected to the amounts on the returns. The taxpayer claimed education, job-search, and employee-business expenses. The Department requested support several times and discussed needed information at an audit meeting.

The taxpayer produced credit-card and bank statements, education-expense printouts, a curriculum list, and mileage logs. Most documents did not identify which transactions belonged to which deduction. There was no reconciliation from the records to the return amounts, and the explanations did not let Virginia determine whether the expenses met federal standards for ordinary and necessary business costs rather than personal expenses.

The taxpayer said the existing backup was enough and declined to provide more. Because the assessment was presumed correct and the taxpayer bore the burden of proof, Virginia had no basis to adjust it on the record then available.

The ruling nevertheless allowed one last 30-day opportunity to submit the information in the required form. Without it, the assessments would become correct as issued and collection would resume.

What this means for you

• Receipts and statements need to be mapped to each return line and claimed amount.
• A useful substantiation package explains the business purpose and why each item meets the applicable deduction rule.
• Large document volumes do not replace a reconciliation.
• Ignoring repeated information requests leaves the assessment's presumption of correctness in place.

Common questions

What records had the taxpayer supplied?

Credit-card statements, bank statements, education records, a curriculum list, and mileage logs.

Why were they insufficient?

They were not clearly tied to particular deductions or reconciled to the amounts claimed.

Was relief finally denied?

Not yet. The taxpayer received one last 30-day period to submit organized support.

Citations and references

• Va. Code §§ 58.1-205, 58.1-219, 58.1-301, 58.1-310, 58.1-322, and 58.1-1826.
• IRC §§ 162 and 262.
• Treas. Reg. § 1.6001-1(a).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 10-78

Original ruling text

May 18, 2010

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 "Taxpayer") for the taxable years ended December 31, 2006 through 2008.

FACTS

For the taxable years at issue, the Taxpayer claimed deductions for educational expenses, job hunting expense and employee business expenses. Under audit, the Department requested information and supporting documentation concerning the expenses claimed. The Taxpayer furnished numerous documents showing expenses, but nothing tied the documents to specific expense amounts reported as itemized deductions. As a result, the deductions at issue were disallowed and assessments for additional tax and interest were issued. The Taxpayer paid the 2008 assessment and then filed an appeal, contending the information provided is sufficient to substantiate the itemized deductions claimed. After assessments for the 2006 and 2007 taxable years were issued, the Taxpayer requested that these taxable years be included in the appeal.

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 Internal Revenue Code (IRC). See Va. Code § 58.1-219.

IRC § 162 provides that a taxpayer generally may deduct from gross income the ordinary and necessary expenses of carrying on a trade or business that are paid or incurred in the tax year. A personal, living or family, expense is not deductible unless the IRC specifically provides otherwise. See IRC § 262. The determination as to whether an expense qualifies for deduction as ordinary and necessary in carrying on a trade or business must take into account all of the facts and circumstances surrounding the expense.

Taxpayers must maintain records sufficient to allow the IRS to determine their correct tax liability. See Treas. Reg. § 1.6001-1(a). Similarly, Va. 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 the case at hand, the Department requested information sufficient to confirm the basis of the expenses claimed. Multiple requests for information were made by the auditor. In addition, the Taxpayer met with the auditor during which additional information was requested. During the course of the audit, the Taxpayer provided credit card statements, bank statements, a copy of a print-out of all college educational expenses, a curriculum list, and mileage logs. Most of the documents fail to clearly identify which transactions are included in which deductions. Furthermore, the Taxpayer has failed to provide a reconciliation between the documentation provided and the deductions claimed. In addition, explanations for the various expenses were not sufficient to determine whether they met the IRC's standards for claiming such deductions.

In his appeal, the Taxpayer states that he had provided adequate back-up documentation, and he would not provide additional documentation. Because the Taxpayer has failed to furnish the required information, there is no basis to adjust the assessments for the 2006 through 2008 taxable years at this time.

Virginia Code § 58.1-205 provides that in 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 that the assessment is incorrect. Further, Va. 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.

Notwithstanding the above, I will allow the Taxpayer one last opportunity to provide the Department with additional information regarding this matter. This information should be mailed to: Virginia Department of Taxation, Office of Tax Policy, Appeals and Rulings, P.O. Box 27203, Richmond, Virginia 23261-7203, Attention: *. Upon receipt, the documentation will be reviewed to determine if a revision to the assessment is appropriate. If the documentation is not provided, in the manner described herein, within 30 days from the date of this letter, the assessments will be considered correct as issued and collection action will resume.

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 website, located at www.tax.virginia.gov. If you have any questions about this determination, you may contact * at ***.

Sincerely,

Janie E. Bowen

Tax Commissioner

AR/1-3915359183.E