I claimed unreimbursed employee expenses plus business expenses for my rideshare driving and refereeing side jobs, using bank statement notations and oil-change mileage receipts as proof -- why did the auditor disallow almost everything?

Plain-English summary

A taxpayer working as a business consultant (with unreimbursed employee expenses) who was also self-employed part-time as a rideshare driver and sports referee claimed a wide range of deductions on his 2017 Virginia return: unreimbursed travel, lodging, and meals on Schedule A for his consulting work, and travel, lodging, meals, home office, advertising, legal/professional fees, office supplies, commissions, and bank fees on Schedule C for his rideshare and refereeing businesses. Under audit, the Department asked for supporting documentation. What the taxpayer provided fell short: receipts from an oil-change business recording total mileage BETWEEN service visits (with no way to tell how much was business driving for consulting, rideshare, refereeing, commuting, or purely personal use), and bank statement printouts with handwritten notations like "business consultant" scrawled next to certain hotel and restaurant charges.

Why this documentation didn't work. The tax code requires much more specific proof for these categories:

• Travel/mileage: substantiation generally requires something like a daily diary or contemporaneous record detailed enough to identify the amount and nature of each expenditure -- an oil-change receipt showing cumulative mileage between visits, with no breakdown by purpose, doesn't come close.
• Lodging: the law disallows a deduction entirely unless the taxpayer substantiates the amount, the time/place of travel, AND the business purpose of each expense -- a notation reading "business consultant" next to a hotel charge on a bank statement doesn't establish any of those three elements with real specificity.
• Meals: similarly requires documentary evidence establishing a clear business purpose (like obtaining new business or maintaining an existing relationship) -- and importantly, a taxpayer can't deduct meals eaten ALONE, even while traveling for business. Bank-statement notations again fell short here too.
• Other Schedule C expenses (advertising, legal/professional services, office supplies, commissions, bank fees) were reduced or disallowed to the extent the taxpayer's documentation didn't match what was claimed.

The home office deduction failed for a different reason: it isn't where the business actually happens. The Supreme Court's controlling standard (from a case involving an anesthesiologist who did his hospital work at hospitals but his paperwork at home) asks WHERE the most important business activities and time actually occur, not just where administrative tasks get done. Here, the most important part of rideshare driving happens while actually driving, and the most important part of refereeing happens at the game venue -- the home, at best, was used for incidental administrative tasks, which doesn't satisfy the "principal place of business" requirement.

Not a total loss, though. The auditor did allow a portion of the meal expenses tied specifically to the refereeing business, where apparently better documentation existed. And critically, this ruling isn't the final word -- the taxpayer was given a further 30 days to submit ADEQUATE documentation (with instructions from the auditor on what would actually satisfy these rules) for any deduction that was disallowed or reduced, before a final bill would issue.

What this means for you

Gig-economy workers (rideshare, delivery, freelance) claiming vehicle and travel deductions

Keep a genuine, contemporaneous mileage log (a dedicated app, notebook, or spreadsheet) that separates business miles by PURPOSE (which job, which trip) from commuting and personal driving -- a repair shop's cumulative mileage-between-visits record, without any purpose breakdown, will not satisfy the IRS's (or Virginia's) substantiation standard.

Anyone deducting business meals or lodging

A vague notation on a bank or credit card statement isn't documentary evidence -- keep receipts (or a log) that separately show the amount, date, place, and specific business purpose of each meal or hotel stay, and remember meals eaten completely alone don't qualify even during business travel.

People running a side business from home (rideshare, referee work, freelance consulting, etc.)

The home office deduction requires the home to be your business's PRINCIPAL place of business -- if the actual income-generating activity happens elsewhere (driving, officiating, meeting clients), using your home only for scheduling, bookkeeping, or similar admin tasks won't qualify, no matter how essential that admin work feels to running the business.

Citations and references

• Rev. Proc. 2010-51 (12/3/2010) -- provides the standard mileage rate method for computing vehicle expense deductions as an alternative to actual operating costs
• IRS Private Letter Ruling 8023052 (3/12/1980) -- addressed deductibility of transportation costs between multiple jobs in the same locality (as opposed to nondeductible commuting)
• Commissioner v. Soliman, 506 U.S. 168 (1993) -- U.S. Supreme Court decision establishing that a home office qualifies as a "principal place of business" only when the relative importance of activities and time spent there predominate over other business locations
• IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses -- describes the recordkeeping methodology for substantiating these categories of business expenses

Subject

Deduction : Itemized - Business Expenses for Meals, Lodging, Mileage, Home Office, Travel, and Other Unreimbursed Expenditures

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-54

Original ruling text

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