Did dismissal of criminal tax charges require Virginia to erase the related income-tax assessment and refund garnished amounts?

Plain-English summary

Virginia kept the underlying 2007 income-tax assessment but removed the 100% fraud penalty. The Department had treated deposits tied to another person's fraudulent mortgage transactions as the taxpayer's unreported income. Some of the assessment had already been collected by wage garnishment.

The dismissal of criminal charges did not automatically erase the civil assessment. Bank deposits are not always income when a taxpayer merely serves as a conduit, but the taxpayer provided no documents showing where the deposited money went. Because a Virginia assessment was presumed correct, the Department treated the unexplained deposits as taxable income.

The fraud penalty had a different outcome. The criminal case did not establish fraud with respect to the 2007 return, so Virginia abated that penalty. The Department issued a revised bill for the remaining tax and interest rather than refunding the entire garnished amount.

What this means for you

• Criminal dismissal and civil tax liability use different standards; one does not automatically resolve the other.
• If money passed through your account for someone else, keep bank records, checks, ledgers, agreements, and other proof tracing the funds.
• Once Virginia issues an assessment, the taxpayer bears the burden of proving it incorrect.
• Penalty relief can be available even when the underlying tax remains due.

Common questions

Q: Did dismissal of the criminal charges cancel the tax assessment?
A: No. Virginia kept the civil assessment because the taxpayer did not document the disposition of the deposits.

Q: Are all bank deposits taxable income?
A: Not necessarily. The ruling recognized that conduit or agency funds may be nontaxable, but evidence is required.

Q: What relief did the taxpayer receive?
A: The 100% fraud penalty was abated.

Q: Were all garnished amounts refunded?
A: No. The determination directed an updated bill for the remaining assessment and interest.

Citations and references

• Va. Code §§ 58.1-1821, 58.1-301, 58.1-322, 58.1-219, 58.1-205, and 58.1-308.
• IRC § 61(a).
• Goe v. Commissioner, 193 F.2d 851 (1952), and Benson Apothaker, T.C.M. 985-445 (1985), discussed on bank deposits and conduit funds.
• Theodore B. Gould v. Commissioner, 139 T.C. 17 (2012), DiLeo v. Commissioner, 96 T.C. 874 (1991), and Michael Scott, T.C.M. 2012-65 (2012), discussed on fraud.

Subject

Denied requests to abate assessment and the amounts garnished be refunded.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-206

Original ruling text

November 7, 2013

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 assessment issued to * (the "Taxpayer") for the taxable year ended December 31, 2007. I apologize for the delay in responding to your appeal.

FACTS

The Department investigated the Taxpayer following the review of her Virginia income tax return, which resulted in criminal charges related to filing false Virginia income tax returns. The evidence included bank statements showing deposits of funds from another individual involved in fraudulent mortgage transactions. That individual was convicted, sentenced, and ordered to pay restitution.

In addition to the criminal charges, the Department concluded that the Taxpayer underreported her Virginia taxable income. The Department made an adjustment equal to funds deposited in her personal checking account from the fraudulent mortgage transactions and issued an assessment. The criminal charges were dismissed by the district court. The Department proceeded to enforce collections on the assessment, with a portion collected through wage garnishments.

The Taxpayer timely filed an appeal, contending the individual responsible for depositing the money into her account was prosecuted and all criminal charges against the Taxpayer have been dismissed. She further asserts that the appropriate amount of income was reported on her federal income tax return. The Taxpayer requests that the assessment be abated and the amounts garnished be refunded.

DETERMINATION

Virginia Taxable Income

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 federal adjusted gross income (FAGI). Income 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 Va. Code § 58.1-322.

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.

The Taxpayer asserts that the criminal charges against her were dismissed and the appropriate income was reported to the Internal Revenue Service (IRS). She further contends that the funds were fraudulently placed into her account by an individual who has been convicted for creating fraudulent mortgage interest statements. Under this reasoning, she believes the Department should not be able to attribute bank account transactions as income to her.

Pursuant to IRC § 61(a), gross income includes all income from whatever source derived, unless excluded by law. "In some circumstances, proof of receipt of funds alone may be sufficient to establish taxable income." See Goe v. Commissioner , 193 F.2d 851, 852-853, (1952). However, the "mere fact that funds are deposited in a bank account does not establish that the deposits are taxable income . . . [A]mounts a taxpayer receives as a mere conduit or agent for transmittal to another are not taxable to him." See Benson Apothaker , T.C.M. 985-445 (1985).

Failure to report an item of income will generally result in an assessment of a deficiency with additional penalty and interest. Here, the Taxpayer received funds deposited into her bank account by an individual conducting fraudulent mortgage transactions. The Taxpayer has provided no documentation to show how these funds were dispersed.

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 that the Department's assessment is improper. Absent any documentation to the contrary, the Department must assume the receipt of these funds constituted taxable income to the Taxpayer.

Fraud Penalty

An individual who has intentionally understated his or her income tax liability with the intent to evade tax is subject to a 100% fraud penalty pursuant to Va. Code § 58.1 -­ 308. For tax purposes, the term "fraud" has been defined as "intentional wrongdoing, with the specific purpose of avoiding a tax believed to be owed." See Theodore B. Gould v. Commissioner , 139 T.C. 17 (2012) and DiLeo v. Commissioner , 96 T.C. 874 (1991). Over the years, courts have developed a list of factors that demonstrate fraudulent intent including: (1) understating income, (2) maintaining inadequate records, (3) implausible or inconsistent explanations of behavior, (4) concealment of assets, (5) failing to cooperate with tax authorities, (6) engaging in illegal activities, (7) an intent to mislead, (8) lack of credibility of the taxpayer's testimony, (9) filing false documents, (10) failing to file tax returns, (11) intelligence, education and expertise of the taxpayer and (12) dealing in cash. See Michael Scott, T.C.M. 2012-65 (2012). "Although no single factor is necessarily sufficient to establish fraud, a combination of factors is more likely to constitute persuasive evidence." See Michael Scott , T.C.M. 2012-65 (2012).

As a result of its investigation, the Department brought charges against the Taxpayer for filing a fraudulent tax return for the 2007 taxable year. The charges for filing fraudulent returns were dismissed by the district court.

CONCLUSION

Based on the information provided, I find no basis to adjust the 2007 tax assessment issued to the Taxpayer. However, because the court failed to find criminal fraud with regard to the Taxpayer's 2007 tax return, the Department will abate the fraud penalty for the 2007 taxable year.

The 2007 assessment will be adjusted in accordance with this determination. An updated bill, with interest accrued to date, will be mailed to the Taxpayer shortly. No further interest will accrue provided the outstanding balance is paid within 30 days from the date indicated of the revised bill.

The Code of Virginia sections cited are available on-line at www.tax.virginia.gov in the Laws, Rules, and Decisions section of the Department of Taxation's web site. If you have any questions about this determination, please contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-4687792772.D