Can Virginia disallow my Schedule C deductions on audit, and will it credit tax withheld from my wages that it added to my income?

Plain-English summary

This is one of the Tax Commissioner's 2026 Schedule C desk-audit determinations (see P.D. 26-42 for the full framework), with one extra wrinkle in the taxpayer's favor. An individual taxpayer claimed business deductions on federal Schedule C for the 2022 through 2024 taxable years. Under audit the Department requested documentation, got no response, disallowed the deductions, and assessed the tax. The taxpayer appealed, arguing the Department "lacks the authority to adjust amounts reported on Schedule C."

The Commissioner applied the usual rules and upheld the disallowance:

• Virginia individual income tax starts from federal adjusted gross income (FAGI) (§ 58.1-301), and the Department may examine and adjust FAGI and deductions inconsistent with the Internal Revenue Code (§ 58.1-219, § 58.1-310) — independently of the IRS.
• A Virginia assessment is "prima facie correct," so the taxpayer bears the burden (§ 58.1-205); § 58.1-1826 can bar court relief for a willful failure to provide required information. The taxpayer got a final 30-day window to submit records.

But the Department also corrected the assessment in the taxpayer's favor. Its review had added unreported W-2 income to the taxpayer's 2023 FAGI, yet it had not credited the $19.26 of Virginia income tax withheld on those wages. Under Va. Code § 58.1-480, amounts withheld from wages are credited against the income tax liability for the year, so the Commissioner directed that the assessment be adjusted to give the withholding credit.

What this means for you

Two lessons. First, substantiation is everything: Virginia can review and disallow your Schedule C deductions on its own, and reporting them on an accepted federal return does not protect you — so keep contemporaneous records and meet the audit deadline. Second, when the Department raises your income by adding unreported wages, make sure any Virginia tax withheld on those wages is credited against the bill (§ 58.1-480); here the Department caught and fixed that itself, but it is worth checking your own assessment for the same credit.

Common questions

Q: Can Virginia disallow deductions I reported on my federal Schedule C?
A: Yes. Virginia starts from your federal numbers but can examine and adjust deductions inconsistent with the Internal Revenue Code (§ 58.1-219, § 58.1-310), and its assessment is prima facie correct (§ 58.1-205).

Q: The Department added wages to my income. Do I get credit for the tax withheld?
A: Yes. Under Va. Code § 58.1-480, Virginia income tax withheld from your wages is credited against your liability for that year — here the Department applied a $19.26 withholding credit it had initially missed.

Q: Do I still have a chance to reduce the assessment?
A: The ruling allowed a final 30 days to submit documentation supporting the deductions; after that the assessment becomes final.

Citations and references

• Va. Code § 58.1-301 — Virginia conforms to IRC terminology; computation starts from FAGI
• Va. Code § 58.1-219 and § 58.1-310 — Department may adjust amounts inconsistent with the IRC and require the federal return and schedules
• Va. Code § 58.1-205 — an assessment is prima facie correct; burden of proof on the taxpayer
• Va. Code § 58.1-480 — Virginia income tax withheld from wages is credited against the taxpayer's income tax liability for the year
• Va. Code § 58.1-1826 — no court relief where the assessment is attributable to a willful failure to provide required information
• Treas. Reg. § 1.6001-1(a) — taxpayers must keep records sufficient to determine the correct tax

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-38

Original ruling text

May 25, 2026

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessments issued to you (the “Taxpayer”) for the taxable years ended December 31, 2022, through 2024.

FACTS

The Taxpayer filed Virginia resident income tax returns for the 2022 through 2024 taxable years claiming deductions on federal Schedule C. Under audit, the Department requested documentation to support the deductions. When no response was received, the Department disallowed the deductions and issued assessments. The Taxpayer applied for correction, contending the Department lacks the authority to adjust amounts reported on Schedule C.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, that the 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 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 .

Generally, 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 appears reasonable, then, typically, the Department does not look behind those computations. The Department, however, may examine and adjust the FAGI and itemized deductions where there is clear evidence that the amounts reported on the federal or Virginia income tax return are inconsistent with the IRC. See Virginia Code § 58.1-219 and § 58.1-310. The Department has consistently exercised this authority in conducting its audit programs. See Public Document (P.D.) 10-126 (07/07/2010), P.D. 12-141 (08/29/2012), P.D. 14-155 (08/28/2014), P.D. 16-53 (04/11/2016), P.D. 19-104 (09/18/2019), and P.D. 21-67 (05/25/2021). In addition, such adjustments have been made independently from any actions taken by the IRS. See P.D. 22-11 (1/18/2022).

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.

Pursuant to Virginia Code § 58.1-205 any assessment of tax by the Department is deemed prima facie correct. This means that the burden of proof is upon the Taxpayer to establish that the assessment is incorrect. Further, 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 taxpayer’s willful failure or refusal to provide the Department with necessary information as required by law.

Because the Taxpayer failed to furnish information required by law, the Department must uphold the assessments for the 2022 through 2024 taxable years.

The Department’s review determined that the Taxpayer had unreported W-2 income that was properly included in the adjustment to federal adjusted gross income for the 2023 taxable year. However, the associated Virginia income tax withholding of $19.26 was not credited against the Taxpayer’s liability. Pursuant to Virginia Code § 58.1-480, amounts withheld from a taxpayer’s wages are credited against their income tax liability for the taxable year. Accordingly, the assessment will be adjusted to reflect the withholding credit.

In addition, the Department will give the Taxpayer one last opportunity to provide adequate documentation. The documentation should be submitted within 30 days from the date of this letter to: Virginia Department of Taxation, Office of Compliance, Desk Audit, RAP, P.O. Box 5610, Richmond, Virginia 23220-0610, Attention: *, Tax Auditor. Upon receipt, the documentation will be reviewed, and the assessments may be adjusted as appropriate. If the documentation is not received within the allotted time, the assessments will be considered correct. In either case, 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 dates to avoid the accrual of additional interest and possible collection actions.

The Code of Virginia sections cited are available online at law.lis.virginia.gov. The public documents cited are available at 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 and Legal Affairs, Tax Adjudication and Resolution Division, at or **@tax.virginia.gov.

Sincerely,

Kristin L. Collins
Tax Commissioner
Commonwealth of Virginia

AR 5450.H

Related Documents

10-126

12-141

14-155

16-53

19-104

21-67

22-11