Could Virginia keep an itemized-deduction adjustment after the IRS withdrew it and the ordinary assessment period expired?

Plain-English summary

Virginia restored the taxpayer's itemized deductions because that part of the July 2011 assessment came after the ordinary three-year deadline. The IRS had initially increased unreported income and disallowed deductions. The taxpayer did not file a Virginia amended return, so Virginia assessed from the federal information.

The taxpayer agreed with the unreported-income portion and paid it. The IRS later withdrew its deduction adjustment. Virginia could independently review deductions, but once it was no longer simply following a final federal change, the ordinary state limitations period applied.

The taxpayer filed the 2006 return in June 2007, giving Virginia three years to assess excess itemized deductions. The July 2011 assessment was more than a year late. Virginia therefore revised the liability to allow those deductions while leaving the other federal-income adjustment in place.

Common questions

Q: Could Virginia assess the unreported federal income after three years?
A: Yes in this case, because the taxpayer failed to report the final federal change as required.

Q: Why was the deduction adjustment different?
A: After the IRS withdrew it, Virginia's separate deduction adjustment was subject to the ordinary three-year assessment limit.

Citations and references

• Va. Code §§ 58.1-219, 58.1-301, 58.1-311, 58.1-312(A)(3), 58.1-322(D)(1), and 58.1-1812.

Subject

IRS waived part of its assessment: Tax assessment filed after the statute of limitations had expired.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-40

Original ruling text

April 6, 2012

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you contest the individual income tax assessment issued to * (the "Taxpayer") for the taxable year ended December 31, 2006.

FACTS

The Taxpayer was audited by the Internal Revenue Service (IRS) for the 2006 taxable year. The IRS adjusted the Taxpayer's gross income to reflect unreported income and disallowed a portion of her itemized deductions on the basis that they were unsubstantiated. As a result, the Taxpayer's federal adjusted gross income (FAGI) was increased. The Taxpayer failed to file amended Virginia income tax returns reflecting the IRS adjustments.

The IRS notified the Department of the changes in the Taxpayer's FAGI, and the Department issued an assessment for additional tax and interest. The Taxpayer appeals the assessment, contending the Department's assessment should be abated because the IRS ultimately waived part of its assessment because it failed to follow proper procedure.

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 FAGI. Further, Va. Code § 58.1-322 D 1 allows a taxpayer to deduct from its Virginia adjusted gross income the amount allowed for itemized deductions for federal income tax purposes.

IRS Adjustments

Virginia Code § 58.1-311 requires any individual to report a change or correction in federal taxable income (FAGI) within one year of the final determination of such change or correction by filing an amended return with the Department. If the taxpayer fails to file an amended return, Va. Code § 58.1-312 A 3 permits the Department to assess the appropriate tax at any time.

In this case, the Department issued assessments based on the information provided by the IRS, as authorized under Va. Code § 58.1-312. Subsequently, the IRS reduced the amount of the assessment. The Taxpayer agreed that she underreported her gross income and paid the resulting assessment. However, the IRS withdrew its assessment with regard to the itemized deductions.

Itemized Deductions

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. However, the Department retains the authority to adjust FAGI where there is clear evidence that the amounts reported on the federal or Virginia income tax return are not consistent with the IRC. See Va. Code § 58.1-219.

While the Department retains the authority to adjust itemized deductions, Va. Code § 58.1-1812 provides that the Department must assess omitted taxes within three years of the later of the due date of the return or the actual date that the return was filed. Because the IRS adjusted its changes with regard to the itemized deductions, the Department would be subject to the statute of limitations in making any adjustments to the Taxpayer's itemized deductions.

The Taxpayer filed her 2006 return in June 2007. As such, the Department had three years from that date to issue an assessment for reporting excess itemized deductions. The Department's assessment was not issued until July 2011, more than a year after the statute of limitations had expired.

Accordingly, the Taxpayer's liability for the 2006 taxable year will be adjusted to allow the itemized deductions. A revised assessment with interest accrued to date will be issued in accordance with the enclosed schedule. The bill should be paid within 30 days of the bill date to avoid the accrual of additional interest.

The Code of Virginia sections cited are available on-line www.tax.virginia.gov in the Tax Policy Library 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/1-4919418262.B