How did Virginia tax mortgage-fraud-related deposits when the taxpayer documented some payments to a business partner?

Plain-English summary

Virginia reduced the assessment to remove deposits the taxpayer proved were passed through to a business partner, but kept the unexplained balance as taxable income. Her husband had deposited mortgage-transaction funds into her account. The records showed later payments to his business partner, although not all deposited amounts were dispersed.

The taxpayer timely filed a protective refund claim. Virginia treated it as an appeal on the merits. Bank deposits are not automatically income when the account holder merely acts as a conduit, but the taxpayer still had to trace the money because the assessment was presumed correct.

The documentation was sufficient for the payments made to the business partner. Those amounts were removed from Virginia taxable income. The remaining deposits stayed taxable because the taxpayer could not show that they were passed on or otherwise nontaxable.

Virginia also abated the 100% fraud penalty because the criminal case did not establish fraud on the 2007 return. After the partial income adjustment and penalty relief, the Department directed a refund of the overpayment with interest.

What this means for you

• A protective claim can preserve a refund issue within the statutory period and may be decided on its merits.
• Bank records can distinguish taxable receipts from money held temporarily for someone else.
• Trace every deposit through canceled checks, transfers, ledgers, and recipient records; only documented pass-through amounts received relief here.
• Criminal dismissal does not automatically cancel a civil tax assessment, but it may affect a fraud penalty.

Common questions

Q: Did Virginia remove every deposit from income?
A: No. It removed only amounts documented as paid to the business partner and kept the undistributed balance taxable.

Q: Why was the refund claim timely?
A: The assessment was issued in December 2010 and the protective claim was filed in February 2012, within the cited three-year period.

Q: What happened to the fraud penalty?
A: It was abated because the court did not find criminal fraud concerning the 2007 return.

Q: Did the taxpayer receive money back?
A: Yes. Virginia directed a refund of the overpayment resulting from the adjustment, with applicable interest.

Citations and references

• Va. Code §§ 58.1-1824, 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 (1953), and Benson Apothaker, T.C. Memo 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

Department to vacate assessment because criminal charges were dismissed

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-207

Original ruling text

November 7, 2013

Re: § 58.1-1824 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek a refund of the Virginia individual income tax paid by your client, * (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, resulting in charges related to filing false Virginia income tax returns. The evidence included bank statements showing deposits connected with a mortgage fraud scheme conducted by her husband and a business partner. The business partner 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 and made an adjustment equal to funds deposited in her personal checking account from the mortgage transactions and issued an assessment. The charges were dismissed by the court and the Department proceeded to enforce collections on the assessments. The Department collected most of the assessment through wage garnishments.

The Taxpayer has filed a claim for refund, contending the amounts deposited by her husband in her personal checking account were not income. She further asserts that the Department must vacate the assessment because the criminal charges against her were dismissed and 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

Protective Claim

Virginia Code § 58.1-1824 permits taxpayers to file a protective claim for refund within three years of the date of an assessment. In this case the assessment was issued in December 2010. The Taxpayer filed her claim for refund in February 2012, well within the three years permitted by statute.

Pursuant to the authority granted the Tax Commissioner under Va. Code § 58.1­-1824, a protective claim for refund can be held pending the outcome of another case before the courts or the claim may be decided based upon its merits pursuant to Va. Code § 58.1-1821. As permitted by statute, the Taxpayers' request has been treated as an appeal under Va. Code § 58.1-1821.

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). 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 (1953). 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. Memo 985-445 (1985).

The Taxpayer provided documentation showing her husband deposited funds in her bank account. Subsequently, payments were made from the account to the business partner. However, not all of the amounts deposited into the account by the husband were dispersed to the business partner.

Under the provisions of Va. Code § 58.1-205, 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 he was not subject to income tax in Virginia. In this case, the Taxpayer is unable to demonstrate that all of the deposits made by her husband were dispersed and the transactions at issue were anything other than income. Therefore, the balance that was not distributed to the business partner will be deemed to be 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).

Based on 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 circuit court.

CONCLUSION

Based on the information provided, the Taxpayer's Virginia taxable income will be adjusted to remove amounts dispersed to the business partner. In addition, 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.

Accordingly, the tax liability for the 2007 taxable year has been adjusted pursuant to the enclosed schedule. A refund of the overpayment will be issued along with applicable interest.

The Code of Virginia sections, along with other reference documents, are available on-line at www.tax.virginia.gov in the Law, Rules and Decisions section of the Department's website. If you have any questions concerning this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5023500066.B