Can Virginia estimate my withholding tax liability using industry payroll norms if I only reported a few employees but had a much larger crew, and what happens if I don't respond to follow-up requests on appeal?

Plain-English summary

A Virginia paving business filed withholding tax returns reporting only two or three employees, but publicly available information showed crews of seven to twenty workers at some of its job sites, and the owner told the auditor during the audit that cash wages were paid to some workers. Because the taxpayer hadn't filed a return covering all its actual workers and had inadequate payment records, the auditor estimated the payroll using industry norms for labor costs as a percentage of gross sales -- a methodology the Department had used before (citing an earlier public document) -- and assessed additional withholding tax for October 2017 through September 2020.

The taxpayer appealed, arguing the Department's estimation methodology was erroneous, but the appeal contained only vague allegations without specifics or supporting evidence. The Department requested more information twice (in March and again in April 2022) and received no response either time. Because a Department assessment is presumed correct and the burden is on the taxpayer to prove otherwise -- and because Virginia law bars a court from granting relief when an erroneous assessment stems from the taxpayer's own willful failure to provide required information -- the Department closed the appeal for failing to meet the basic requirements for a complete appeal, and the assessments stood as issued, with interest continuing to accrue until paid.

What this means for you

Employers who pay some workers in cash or off the books

If your reported workforce doesn't match what's publicly observable at your job sites (crew sizes, hours, project scope), expect an auditor to notice the mismatch and estimate your payroll using industry labor-cost benchmarks rather than accepting an incomplete return at face value.

Anyone appealing a Virginia tax assessment

A successful appeal needs specifics and evidence, not just a general assertion that the Department's numbers are wrong. Respond promptly and completely to every follow-up document request -- ignoring them, as happened here, can get your appeal closed without ever reaching the merits.

Accountants and tax professionals

Be aware of Va. Code § 58.1-1826: if an assessment turns out to be erroneous because the taxpayer WILLFULLY failed or refused to provide required information, a Virginia circuit court is barred from granting relief even later. That makes responding fully to Department information requests during the administrative appeal critical -- there may be no second bite at a court challenge if you don't.

Common questions

Q: Can the Department estimate my payroll using industry averages if my actual records are incomplete?
A: Yes -- Va. Code § 58.1-111 allows the Department to estimate tax due from any information in its possession when a correct and complete return hasn't been filed, including industry norms for labor costs as a percentage of gross sales.

Q: What happens if I don't respond to the Department's follow-up requests during an appeal?
A: As happened here, the Department can close the appeal for failing to meet the requirements for a complete appeal under 23 VAC 10-20-165 D, leaving the original assessment in place.

Q: Who has the burden of proof once a Virginia assessment is issued?
A: The taxpayer. Under Va. Code § 58.1-205, an assessment is presumed prima facie correct, and the taxpayer must affirmatively show it's wrong.

Q: Can a Virginia court later overturn an assessment I didn't fully respond to during the appeal process?
A: Not if the erroneous assessment resulted from your own willful failure or refusal to provide required information -- Va. Code § 58.1-1826 bars court relief in that situation.

Citations and references

• Va. Code § 58.1-111 (Department may estimate tax due when a correct return isn't filed)
• Va. Code § 58.1-205 (assessment presumed prima facie correct)
• Va. Code § 58.1-1826 (court relief barred for willful failure to provide required information)
• 23 VAC 10-20-165 D (requirements for a complete appeal)
• P.D. 12-75 (5/9/2012) (industry-norm payroll estimation methodology)

Subject

Administration - Assessment: Burden of Proof; Audit: Methodology When Records Are Absent

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-50

Original ruling text

May 3, 2023

Re: § 58.1-1821 Application: Withholding Tax

Dear *:

This will respond to your letter in which you seek correction of the withholding tax assessments issued to * (the “Taxpayer”) for the taxable periods October 2017 through September 2020.

FACTS

The Taxpayer operated a paving business in Virginia. Under audit, the Department concluded that the Taxpayer had underreported its wages and owed additional withholding tax for the periods October 2017 through September 2020. As a result, assessments were issued for withholding tax due. The Taxpayer appealed the assessments, contending the Department’s methodology in computing the assessments was erroneous and the assessments should be abated based on the facts and circumstances.

DETERMINATION

The Taxpayer filed withholding returns for the taxable periods at issue, reporting tax withheld for two or three employees. Publically available information, however, showed that crews of seven to twenty individuals worked at some of the Taxpayer’s job sites. During conversations with the Taxpayer, he told the auditor that cash wages were paid to some workers.

Pursuant to Virginia Code § 58.1-111, when a taxpayer fails to file a correct and proper return, the Department may make an estimate of the tax due from any information in its possession. In this case, because the Taxpayer did not file a return that included all workers and provided inadequate records of payments to workers for the periods under review, the auditor estimated the Taxpayer’s payroll based on industry norms for labor costs as a percentage of gross sales. See Public Document (P.D.) 12-75 (5/9/2012).

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 the assessments were incorrect. Furthermore, Virginia 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 taxpayers’ willful failure or refusal to provide the Department with necessary information as required by law.

The Taxpayer’s appeal made only vague allegations regarding the correctness of the audit assessments. The Department requested additional information on March 16, 2022. When no information was received, the Department sent a follow-up request on April 14, 2022. To date, the Taxpayer has failed to respond with the requested information. Because the Taxpayer has failed to submit a complete appeal as prescribed under Title 23 of the Virginia Administrative Code (VAC) § 10-20-165 D, the request for correction is being closed.

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 cited are available online at www.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, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3904.X

Related Documents

12-75