Did foreclosure-related loss of records excuse taxpayers from substantiating itemized and vehicle-expense deductions?

Plain-English summary

Virginia upheld the assessments because the taxpayers did not adequately substantiate their deductions. They said records were lost when their home was foreclosed in 2009, but the record did not show attempts to recreate them through banks, medical providers, charities, or government agencies.

The wife, a police officer, claimed standard-mileage employee expenses without documentation that she used her personal car for work. The couple's truck-leasing business also claimed the standard mileage rate while separately deducting operating costs. Virginia disallowed the mileage deduction for 2007 because actual truck expenses were higher and found the evidence inconclusive about whether depreciation rules allowed a change of method for 2008.

Virginia assessments are presumed correct under Va. Code § 58.1-205. Because the taxpayers did not carry their burden with sufficient records, the Department upheld the additional tax, penalty, and interest for both years.

What this means for you

• Reconstruct lost deduction records from third parties when possible.
• Document personal-vehicle business use, especially when an employer normally supplies transportation.
• Do not combine the standard mileage rate with separate deductions for costs it already covers.
• Keep depreciation-method records before switching between actual expenses and mileage.

Citations and references

• IRC §§ 67(b) and 162.
• Treas. Reg. § 1.6001-1(a).
• Va. Code §§ 58.1-205, 58.1-219, 58.1-301, 58.1-310, and 58.1-322(D)(1).

Subject

Taxpayers unable furnish to sufficient information to substantiate their deductions

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 11-108

Original ruling text

June 14, 2011

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 year ended December 31, 2007 and 2008.

FACTS

The Department audited the Taxpayers' Virginia individual income tax returns for the 2007 and 2008 taxable years. The auditor adjusted the itemized deductions for the 2007 taxable year and disallowed the itemized deductions claimed for 2008 based on documentation provided by the Taxpayers.

The Department issued assessments for additional tax, penalty and interest for the years in question. The Taxpayers appeal the assessments, contending that many of the documents required to substantiate the itemized deductions were lost during a foreclosure proceeding.

DETERMINATION

Virginia Code § 58.1-301 provides 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.

Itemized Deductions

Virginia Code § 58.1-322 D 1 allows a taxpayer to deduct from its Virginia adjusted gross income the amount allowed for itemized deductions for federal income tax purposes. Under the IRC, itemized deductions, subject to certain limitations are permitted to individuals for medical expenses, certain taxes and interest, and charitable contributions. The Taxpayers are required to 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.

As permitted by statute, the Department requested that the Taxpayers provide substantiation of their deductions for the taxable years at issue. The Taxpayers were able to provide documentation for most of the deductions claimed for the 2007 taxable year, but were unable to recover a number of documents after they lost their home to a foreclosure action in 2009.

Generally, government agencies, banks, medical businesses, and charitable organizations maintain forms, statements or records of payments received from individual customers or donors. The information provided does not indicate whether the Taxpayers have attempted to recreate their records for the taxable years at issue.

Employee Business Expenses

Individuals that claim itemized deductions may deduct miscellaneous itemized deductions, as defined under IRC § 67(b) to the extent that they collectively exceed 2% of FAGI. One such miscellaneous itemized deduction is for unreimbursed employee business expenses.

For the taxable years at issue the wife, a police officer, computed a unreimbursed employee business expense deduction for vehicle expenses based on the standard mileage rate. The Department questioned this deduction because police officers are usually provided with a motor vehicle for transportation purposes. The Taxpayers have provided no documentation to show that the wife used her personal automobile for business purposes.

Profit or Loss from a Business

Under IRC § 162, taxpayers are permitted to deduct all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. The Internal Revenue Service (IRS) generally allows two methods for determining deductible transportation costs. A taxpayer may use actual expenses associated with operating a motor vehicle in connection with a trade or business, or a taxpayer may claim the standard mileage rate to compute the allowable deduction for transportation costs. Deductions claimed using the standard mileage rate are permitted in lieu of actual expense deductions for depreciation or lease payments, maintenance and repairs, tires, gasoline, oil, insurance, and registration fees.

In this case, the Taxpayers were in the business of leasing a truck and a driver to a delivery business. For both of the taxable years at issue, the Taxpayers deducted car and truck expenses using the standard mileage rate. In addition, the Taxpayers deducted expenses for repairs, truck washes, and gasoline for the 2007 taxable year and truck repairs for the 2008 taxable year.

For 2007, the actual expenses for operating the truck exceeded the deduction computed using the standard mileage rate. The Department disallowed the deduction for the standard mileage rate. Although taxpayers are not prohibited from switching between the two methods, certain rules relating to depreciation methods govern whether such a change is allowed. The evidence provided is inconclusive as to the method of depreciation used to deduct actual expenses of the truck. Therefore, the Department appropriately disallowed the standard mileage rate deduction for the 2008 taxable year.

CONCLUSION

Pursuant to Va. Code § 58.1-205 any assessment of tax by the Department is deemed prima facie correct. This means the burden of proof is upon the Taxpayer to establish that the assessment is incorrect. Because the Taxpayers have been unable furnish to sufficient information to substantiate their deductions, I must uphold the Department's assessments for the 2007 and 2008 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 in 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 ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4585862613.D