I claimed vehicle and other business expenses on Schedule C for three years, plus a Form 2106 deduction for one of those years, but the auditor said my repair receipts and bank statements weren't enough proof -- what documentation would have actually worked?

Plain-English summary

This ruling is a detailed, practical roadmap of exactly what documentation the IRS (and by extension Virginia) actually requires for common self-employment deductions -- and it shows several plausible-looking types of proof that still fall short.

The taxpayer claimed vehicle and other business expenses on Schedule C for 2018, 2019, and 2020, plus employee business expenses on Form 2106 for 2019. Virginia generally defers to federal return numbers, but retains authority under Va. Code § 58.1-219 to adjust FAGI and deductions where there's clear evidence they're not properly substantiated under the Internal Revenue Code, a long-exercised authority (citing six prior rulings).

Form 2106 (2019): As explained in other rulings from this same era, the 2017 Tax Cuts and Jobs Act limited Form 2106 to Armed Forces reservists, qualified performing artists, and fee-based state or local officials for 2018-2025. The taxpayer admitted he wasn't in any of those groups -- an independent, complete bar regardless of documentation -- and he also provided no documentation supporting the claimed amount anyway.

Vehicle expenses (Schedule C, all three years): This is the ruling's most instructive part. Vehicle and travel expenses face a HEIGHTENED substantiation standard under IRC § 274(d) -- a mileage log showing dates, times, locations, business purpose, and mileage is specifically required to allocate business versus personal use, whether you're claiming the standard mileage rate or actual expenses (and you can't mix both methods for the same vehicle in the same year, per Rev. Proc. 2010-51). The taxpayer submitted plenty of vehicle repair and service invoices -- but with only two exceptions, none of them were accompanied by actual proof of payment (a receipt or cancelled check), and NO mileage log was ever provided. Invoices alone, without proof you paid them and without a log showing business-use percentage, don't meet the bar.

Other business expenses: For phone service, legal fees, insurance, and supplies, the taxpayer submitted business bank statements showing payments to pharmacies, grocery stores, convenience stores, and restaurants -- but with no notation, receipt, or explanation connecting any of these charges to an actual business purpose. A bank statement entry alone, without something explaining why a grocery-store or restaurant charge was a legitimate business expense, isn't sufficient proof.

The one item that worked: A $275 filing fee paid to the Virginia State Corporation Commission in 2020 to reinstate the taxpayer's LLC -- because he actually provided proof of payment for that specific charge, the Department allowed it and adjusted the 2020 assessment accordingly. Everything else was upheld as assessed.

What this means for you

Anyone claiming vehicle expenses on Schedule C (or any business return)

Keep a contemporaneous mileage log -- dates, times, locations, business purpose, and miles driven -- regardless of whether you use the standard mileage rate or actual expenses. Repair and service invoices alone, without a mileage log AND without proof you actually paid them, won't satisfy the IRS's heightened substantiation rules for vehicle expenses.

Anyone claiming business expenses reflected only in a bank or credit card statement

A bank statement line item isn't self-explanatory. Keep receipts, invoices, or contemporaneous notes connecting each charge to an actual, specific business purpose -- especially for expense types (like meals, supplies, or personal-adjacent purchases) that could plausibly be personal rather than business.

Anyone claiming both the standard mileage rate and actual vehicle expenses in the same year

You can't do both for the same vehicle in the same tax year -- choose one method, and document it properly regardless of which you pick.

Anyone with at least one properly-documented expense among a mostly-undocumented claim

Partial documentation can still produce a partial win -- here, one $275 filing fee with actual proof of payment was allowed even though nearly everything else in the same audit was disallowed. Document what you can, even if you're missing records for other items.

Common questions

Q: I have vehicle repair invoices -- isn't that enough to support my Schedule C vehicle expense deduction?
A: No. You also need proof you actually paid those invoices (a receipt or cancelled check) AND a mileage log showing dates, business purpose, and mileage to properly allocate business versus personal use -- invoices alone don't satisfy the heightened substantiation standard for vehicle expenses.

Q: My business bank statement shows payments that were for business purposes -- isn't that documentation enough?
A: Not by itself. Without a notation, receipt, or other explanation connecting a specific charge to a business purpose, an unexplained bank statement entry (especially one that could look personal, like a grocery store or restaurant charge) won't support the deduction.

Q: Can I claim both the standard mileage rate and actual expenses like gas and repairs for the same vehicle in the same year?
A: No -- you must choose one method per vehicle per year, and even the actual-expense method still requires a mileage log to allocate business versus personal use.

Q: If most of my claimed expenses lack documentation, will the whole deduction be disallowed?
A: Not necessarily all of it -- items you CAN document (here, a filing fee with actual proof of payment) can still be allowed even while other undocumented items in the same audit are disallowed.

Citations and references

• Va. Code § 58.1-301 (Virginia conforms to IRC terminology/references unless a different meaning is clearly required)
• Va. Code § 58.1-219 (Department authority to adjust FAGI and itemized deductions inconsistent with the Internal Revenue Code)
• IRC § 162 (deduction for ordinary and necessary business expenses connected to a trade or business)
• IRC § 274(d) (heightened substantiation requirement for vehicle, travel, and similar expenses, including a mileage log)
• IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses (documentation guidance for vehicle expense deductions)
• Rev. Proc. 2010-51, § 4.02 (12/3/2010) (a taxpayer using the standard mileage rate cannot also claim actual vehicle expenses for the same vehicle)
• P.D. 14-155 (8/28/2014), P.D. 19-78 (7/29/2019) (proof of payment, such as receipts or cancelled checks, is required to substantiate claimed expenses)
• Treas. Reg. § 1.6001-1(a) (taxpayers must maintain records sufficient to determine correct tax liability)
• Va. Code § 58.1-310 (Department may require production of federal returns and supporting schedules for audit purposes)
• Va. Code § 58.1-205 (Department assessments are prima facie correct; burden of proof is on the taxpayer)

Subject

Deduction : Business Expenses - Taxpayer Records, Lack of Documentation

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-44

Original ruling text

March 15, 2022

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, 2018, 2019 and 2020.

FACTS

The Taxpayer filed Virginia resident income tax returns for the 2018, 2019 and 2020 taxable years claiming deductions for vehicle and other expenses on federal Schedule C and on federal Form 2106 (2019 only). Under audit, the Department requested documentation to support the deductions. The Taxpayer submitted some documentation, but the auditor determined it was insufficient to support the claimed expenses. The Department, accordingly, disallowed the deductions and issued assessments. The Taxpayer appeals the assessments, contending the Department lacks authority to adjust amounts reported on federal tax forms.

DETERMINATION

Conformity

Virginia Code § 58.1-301 provides, with certain exceptions, 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. 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 with federal adjusted gross income (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. 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. The Department has regularly 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). In addition, the adjustments in these cases have been made independently from any actions taken by the IRS.

Form 2106 Deduction

The Taxpayer claimed an adjustment to federal gross income in 2019 for employee business expenses on Form 2106. For the 2019 taxable year, an adjustment to income could be claimed on Form 2106 only by certain individuals, including Armed Forces reservists, qualified performing artists, and fee-based state or local officials. The Taxpayer’s response indicated that he was not a member of one of those classes of individuals and, regardless, he did not provide any documentation to support the claimed expenses.

Schedule C Expenses

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 auditor requested that the Taxpayer provide documentation supporting the expenses claimed on Schedule C for the 2018, 2019 and 2020 taxable years. The requests clearly indicated the documentation required to substantiate each type of expense.

To substantiate car and truck expenses the auditor requested, among other things, a mileage log. A mileage log show the dates, times and locations of travel as well as the business purpose and mileage. A mileage log or similar documentation is required to properly allocate miles driven between personal and business use. See IRC § 274(d) and IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses. The Taxpayer, however, did not submit any mileage logs.

The Taxpayer did submit numerous vehicle repair and service invoices, but no proof of payment was provided with the exception of one repair receipt in 2018 and one in 2020. Substantiating payment of expenses through items such as a receipts or cancelled checks is required to claim the deductions. See P.D. 14-155 (8/28/2014) and P.D. 19-78 (7/29/2019). Further, if a taxpayer claims vehicle expenses based on the standard mileage rate, he may not also claim actual expenses such as for automobile repair or gas. See Rev. Proc. 2010-51, § 4.02 (12/3/2010). Even if the Taxpayer chose to claim actual vehicle expenses, documentation, such as a mileage log, would still be necessary to properly allocate those expenses between business and personal use. See IRS Publication 463.

The Taxpayer also claimed additional expenses that were not vehicle-related expenses, such as for mobile phone service, legal services, insurance and supplies. The Taxpayer submitted business bank statements which show assorted payments to pharmacies, grocery stores, convenience stores and restaurants. The Taxpayer did not include any notations, receipts or bills that would justify the business purpose of any of those payments. The auditor disallowed these expenses because the Taxpayer failed to provide sufficient documentation. A review of the documentation, however, shows the Taxpayer did submit proof of payment for a $275 filing fee paid to the Virginia State Corporation Commission in 2020 to reinstate his limited liability company.

CONCLUSION

Taxpayers must maintain records sufficient to allow the IRS to determine their correct tax liability. See Treas. Reg. § 1.6001-1(a). Similarly, Virginia 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 properly to 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.

Under the provisions of Virginia Code § 58.1-205, 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 was erroneous.

Sufficient documentation has not been provided by the Taxpayer to support the employee business expense deduction claimed on Form 2106 for the 2019 taxable year or the vehicle expense deductions claimed on the Taxpayer’s Schedules C submitted with his 2018, 2019 and 2020 federal income tax returns. Further, with the exception of the filing fee discussed above, the Taxpayer did not provide sufficient documentation to support the other claimed business expenses. Because the Taxpayer has indicated that he does not have any further documentation, there is no basis to abate the Department’s assessments for the 2018 and 2019 taxable years. The assessment for the 2020 taxable year will be adjusted by the auditor to allow the filing fee expense.

The Taxpayer will receive updated bills that will include accrued interest to date. The Taxpayer should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest and possible collection actions.

The Code of Virginia sections and public documents 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/3958.X

Related Documents

10-126

12-141

14-155

16-53

19-104

21-67