Can Virginia audit federal Schedule C deductions and disallow them when taxpayers do not provide supporting records?

Subject

Federal Adjusted Gross Income (FAGI) : Sole Proprietorship - Schedule C Audit; Administration : Audits - Taxpayer Records

Plain-English summary

Virginia upheld the disallowance of the taxpayers' 2022-2024 Schedule C deductions because they did not provide records supporting the deductions.

The taxpayers argued that Virginia lacked authority to adjust amounts reported on a federal Schedule C. The Department disagreed. Virginia generally starts with federal adjusted gross income and usually relies on the federal return, but it may examine and adjust federal-return amounts when clear evidence indicates they are inconsistent with the Internal Revenue Code.

Virginia and federal rules require taxpayers to keep and produce records supporting their returns. An assessment is presumed correct, so the taxpayers had the burden to prove that the disallowance was wrong. Their failure to respond to the audit request left the assessments in place.

The Department nevertheless gave the taxpayers one final 30-day period under the ruling to submit adequate documentation. It said the assessments could be adjusted after review; without the records, they would be treated as correct.

What this means for you

• Reporting a deduction on a federal Schedule C does not prevent Virginia from auditing it.
• Keep invoices, receipts, ledgers, mileage logs, and other records needed to establish each claimed business expense.
• If Virginia asks for substantiation, failing to respond can cause the deductions to be disallowed and leave the assessment presumed correct.
• Virginia can make its own adjustment even if the IRS has not changed the federal return.
• A final chance to provide records in this ruling was case-specific and should not be assumed in another audit.

Common questions

Does Virginia always recalculate federal adjusted gross income?

No. The Department said it generally relies on reasonable federal-return information, but it can look behind the return when there is clear evidence that reported amounts conflict with federal law.

Why did the taxpayers bear the burden of proof?

Va. Code § 58.1-205 makes a Department assessment prima facie correct. The taxpayers therefore had to establish that the assessments were wrong.

Did the ruling permanently deny every deduction?

It upheld the assessments on the existing record but allowed the taxpayers one last 30-day opportunity to submit adequate documentation for review and possible adjustment.

Could Virginia act without an IRS adjustment?

Yes. The ruling states that Virginia has made these adjustments independently of IRS action.

Citations and references

• Va. Code § 58.1-301, federal conformity and the starting point for Virginia taxable income.
• Va. Code §§ 58.1-219 and 58.1-310, authority to audit returns and require supporting federal returns, statements, inventories, and schedules.
• Va. Code § 58.1-205, presumption that an assessment is correct.
• Va. Code § 58.1-1826, consequences when an erroneous assessment results from willful failure or refusal to provide required information.
• Treas. Reg. § 1.6001-1(a), federal recordkeeping requirement.
• P.D. 10-126, 12-141, 14-155, 16-53, 19-104, 21-67, and 22-11, cited by the Department for its audit authority and practice.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-57

Original ruling text

June 3, 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 “Taxpayers”) for the taxable years ended December 31, 2022, through 2024.

FACTS

The Taxpayers 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 Taxpayers 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 Taxpayers to establish that the assessments are 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 Taxpayers failed to furnish information required by law, the Department must uphold the assessments for the 2022 through 2024 taxable years. The Department will, however, give the Taxpayers 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 Taxpayers will receive updated bills that will include accrued interest to date. The Taxpayers 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 Legal Affairs, Tax Adjudication and Resolution Division, at or **.

Sincerely,

Kristin L. Collins
Tax Commissioner
Commonwealth of Virginia

AR 5354.H

Related Documents

10-126

12-141

14-155

16-53

19-104

21-67

22-11