Could Virginia residents avoid a 2008 assessment based on an IRS income adjustment by arguing they had not pledged income or contracted with the Department?

Subject

IRS income adjustment supported Virginia assessment

Plain-English summary

Virginia upheld the 2008 assessment because the IRS reported higher federal adjusted gross income and the taxpayers did not show that information was wrong. Virginia individual taxable income starts with federal adjusted gross income unless a specific Virginia modification applies.

Taxpayers must report a final federal-return change to Virginia within 90 days. If they do not, federal law permits the Department to obtain IRS information and use it to determine additional Virginia liability.

The couple argued that they had no fiduciary contract with the Department and had not gifted or pledged their wages. The Commissioner rejected those theories: Virginia may tax all income of its residents, and tax liability does not depend on a private contract or voluntary pledge.

Assessments are presumed correct, so the taxpayers bore the burden of producing objective evidence. They provided none contradicting the IRS adjustment. The ruling also warned generally that deliberately failing to file based solely on such theories can support a 100% fraud penalty, but it did not say that this couple's 2008 assessment included that penalty.

What this means for you

• Report final federal audit changes to Virginia within 90 days.
• If the IRS data is wrong, provide records or a corrected federal determination rather than legal theories about consent.
• Virginia residents are taxable on income included in federal adjusted gross income unless a Virginia modification applies.
• The Department's assessment starts as presumptively correct in an appeal.

Citations and references

• Va. Code §§ 58.1-205, 58.1-301, 58.1-302, 58.1-308, 58.1-311, and 58.1-322.
• IRC § 6103(d).

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-84

Original ruling text

June 4, 2014

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter concerning the Virginia individual income tax assessment issued to * (the Taxpayers), for the taxable year ended December 31, 2008. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayers, a husband and wife, filed a 2008 joint Virginia individual income tax return. The Department received a federal audit adjustment from the Internal Revenue Service (IRS) indicating that the Taxpayers underreported their federal adjusted gross income (FAGI). As a result, the Department issued an assessment for additional tax and interest. The Taxpayers appeal the assessment, contending they had no intention to gift or pledge any tax to the Department and they have no fiduciary contracts with the Department.

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 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. 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 Va. Code § 58.1-322.

IRS Information

Virginia Code §58.1-311 requires that any change made on the federal return must be reported to the Department on an amended Virginia return within ninety (90) days from the final determination of such change on the federal return. If an amended return is not filed with the Department, IRC § 6103(d) authorizes the Department to obtain information from the IRS that will assist in determining any additional tax liability.

The Department received information from the IRS indicating that the Taxpayer's income had been underreported for the 2008 taxable year and the FAGI had been adjusted accordingly. Because Virginia's taxable income begins with the FAGI, the Virginia return was adjusted based on federal date and an assessment was issued.

Taxability of Income

The Taxpayers argue they did not enter into a fiduciary contract with the Department, thus granting the Department to act in their personal matters. In addition, the Taxpayers state that they have not pledged their wages to the Department and request remuneration of all previously assumed gifts.

The United States Supreme Court has opined:

A tax measured by the net income of residents is an equitable method of distributing the burdens of government among those who are privileged to enjoy its benefits. The tax, which is apportioned to the ability of the taxpayer to pay it, is founded upon the protection afforded by the state to the recipient of the income in his person, in his right to receive the income and in his enjoyment of it when received. See New York ex rel. Cohn v. Graves , 300 U.S. 308, 313, 57 S.Ct. 466, 467 (1937).

In addition, it has been well-established that a state may tax all the income of its residents, even income earned outside the taxing jurisdiction. In New York ex rel. Cohn , 300 U.S. at 312, 57 S.Ct. at 467, the United States Supreme Court explained "[t]hat the receipt of income by a resident of the territory of a taxing sovereignty is a taxable event is universally recognized." Thus, any resident who has Virginia taxable income as determined under Virginia's statutes is subject to Virginia income tax.

The Taxpayers resided in Virginia and would be considered to be natural persons that meet the definition of a resident of Virginia pursuant to Va. Code § 58.1-302. The Virginia Supreme Court has held "the power of the State of Virginia to levy taxes is not derived from the Constitution of the United States as interpreted by the Supreme Court. On the contrary, the State has the inherent and unlimited power of taxation unless restrained by its Constitution or the Constitution of the United States." See Colonial Pipeline Company v. Commonwealth of Virginia , 206 Va. 517, 523, 145 S.E.2d 227, 232 (1965).

The information obtained from the IRS contradicts the Taxpayers arguments. Because the computation of an individual's Virginia income tax starts with FAGI, the Department properly adjusted the Taxpayers' Virginia taxable income based on information obtained under IRC § 6103(d).

The Taxpayer has provided no information that would show the IRS information is in error. Because notification was issued by the IRS that the Taxpayers underreported their income, and the Taxpayers failed to correct the underreporting with the Department, the Department was well within its authority to issue an assessment against the Taxpayers.

As such, the claim that the Taxpayers' income is not subject to Virginia taxation has no basis in fact or Virginia law. An individual who fails to file Virginia income tax returns based solely on such claims has intentionally understated his or her income tax liability with the intent to evade tax and is subject to a 100% fraud penalty pursuant to Va. Code § 58.1-308.

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 Taxpayers to show they were not subject to income tax in Virginia. In this case, the Taxpayers have provided no objective evidence to show that the Department's assessment was incorrect.

Based on the applicable law cited above and the information presented, there is no basis to revise or abate the Department's assessment for the 2008 taxable year. Accordingly, the 2008 assessment is correct and remains due and payable. An updated assessment will be issued shortly, which will include interest accrued to date. Payment of the assessment should be made within 30 days of the bill date in order to avoid the accrual of additional interest.

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

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5249009514.D