The Department disallowed our itemized deductions and Schedule E expenses when we didn't respond to a documentation request in time -- can we still get the medical expense deduction back by showing we already sent proof?

Plain-English summary

A husband and wife filed Virginia resident income tax returns for 2017 through 2019. During an audit, the Department asked for documentation supporting their itemized deductions (Schedule A) each year, and for their Schedule E rental/business expenses in 2018 and 2019. When the couple didn't respond, the Department disallowed the itemized deductions and Schedule E expenses entirely, applied the standard deduction instead, and issued assessments for the resulting additional tax. The couple appealed, insisting they HAD already submitted documentation to substantiate their medical expenses specifically.

Virginia generally trusts the federal return, but can look behind it when something doesn't check out. Since Virginia income tax starts from federal adjusted gross income and generally conforms to federal rules, the Department typically relies on the federal numbers -- but retains authority to adjust deductions when there's clear evidence they're inconsistent with federal tax law, including simply failing to substantiate them when asked. Medical expenses specifically require a statement or itemized invoice from the provider showing the type of service, the patient, and the amount and date of payment. The couple's Schedule E deductions (covering rental real estate, royalties, partnership/S-corp income, and similar items) were similarly disallowed for lack of documentation.

The key problem: the Department has no record of ever receiving the couple's documentation. Whatever the couple believed they'd submitted, it apparently never reached the Department's file. Complicating matters, the auditor who originally handled the case was no longer with the Department. Rather than simply denying the appeal outright, the Tax Commissioner gave the couple a concrete path forward: send the medical-expense documentation (and, implicitly, anything else supporting the disallowed items) to a specific Office of Compliance address by a firm deadline tied to when the original adjustments were made. If the documentation arrives in time, the audit staff will review it, adjust the assessments as warranted, and notify the couple of the results (with a further 90-day appeal window if they still disagree). If it doesn't arrive in time, the assessments stand as issued and collection activity resumes.

What this means for you

Taxpayers who believe they've already sent documentation to the Department

Keep your OWN proof of submission (certified mail receipts, fax confirmations, email records) -- if the Department has no record of receiving something, simply asserting you sent it isn't enough; you may need to resend it, and a firm deadline may apply.

Taxpayers claiming a medical expense deduction

Make sure your documentation specifically shows the type of service or item, who received it, and the amount and date of payment -- generic receipts or statements missing these details won't satisfy the substantiation requirement.

Anyone appealing a disallowed deduction where the original auditor has since left

Don't assume institutional continuity -- if key Department staff have turned over, you may be directed to a different office or contact, and it's worth confirming exactly where and to whom any follow-up documentation should be sent.

Common questions

Q: I believe I already sent documentation for my medical expenses -- why did the Department still disallow the deduction?
A: Because the Department's file shows no record of ever receiving it. Even if you believe you submitted it, you may need to resend the documentation to have it actually considered.

Q: What happens if I miss the deadline to resubmit documentation after an appeal like this?
A: The assessments are treated as correct, and collection actions resume -- missing the deadline effectively forfeits the opportunity this ruling extended.

Q: If I submit new documentation and the Department still disagrees with part of it, do I get another chance to appeal?
A: Yes -- once the audit staff reviews the documentation and issues its results, you have 90 days from that notification to file a further appeal if you still disagree.

Citations and references

• No outside Public Documents beyond the Code of Virginia sections and Treasury Regulations cited above are referenced in this ruling.

Subject

Administration : Appeal - Federal Information; Deduction : Itemized - Medical Expenses; Federal Adjusted Gross Income (FAGI) : Expenses - Schedule E, REMIC

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 21-67

Original ruling text

May 25, 2021

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 assessments issued to * (the “Taxpayers”) for the taxable years ended December 31, 2017, through 2019.

FACTS

The Taxpayers, a husband and wife, filed Virginia resident income tax returns for the 2017 through 2019 taxable years. Under audit, the Department requested documentation to support itemized deductions reported on Schedule A of the federal tax returns for each taxable year. The Department also requested documentation to verify expenses claimed on Schedule E for the 2018 and 2019 taxable years. When a response was not received, the Department disallowed the itemized deductions and expenses, applied the standard deduction, and issued assessments for each taxable year. The Taxpayers appeal, contending they submitted information to substantiate their medical expenses.

DETERMINATION

Conformity

Virginia Code § 58.1-301 provides, with certain exceptions, 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. Conformity does not extend to terms, concepts, or principles not specifically provided in the Code of Virginia . 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 .

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 the FAGI and itemized deductions where there is clear evidence that the amounts reported on the federal or Virginia income tax return are not consistent with the IRC. See Virginia Code § 58.1-219.

Itemized Deductions

Virginia Code § 58.1-322.03 1 allows an individual to deduct from their Virginia adjusted gross income certain amounts allowed for itemized deductions for federal income tax purposes. When the Taxpayers did not produce documentation to substantiate itemized deductions claimed for medical expenses, real estate taxes, home mortgage interest, unreimbursed business expenses and certain other miscellaneous expenses, the Department denied the deductions and applied the standard deduction. On appeal, the Taxpayers assert that they submitted documentation regarding their medical expenses.

For the taxable years at issue, IRC § 213 allowed as a deduction the expenses paid for medical care of a taxpayer, their spouse, or a dependent to the extent that such expenses exceed 7.5% of FAGI. Treas. Reg. § 1.213-1(h) requires taxpayers to substantiate medical expenses, by providing a statement or itemized invoice from the individual or entity providing the service showing the type of service performed or item purchased, the patient the service was performed on, and the amount and date of payment. The Taxpayers should be aware that the Department has no record of having received documentation regarding their medical expenses.

Supplemental Income and Loss - Schedule E

Schedule E is used to report income or loss from rental real estate, royalties, partnerships, S corporations, estates, trusts, and residual interests in real estate mortgage investment conduits (REMICs). Income from such entities is offset by expenses. This income or loss is reported on a taxpayer’s federal income tax return and thus is reflected in FAGI reported on the Virginia return. In this case, the Department disallowed expenses reported on Schedule E when the Taxpayers failed to provide documentation to substantiate them.

CONCLUSION

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 Taxpayer to establish that the assessment is incorrect. Taxpayers must maintain records sufficient to allow the IRS to determine their correct 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 to properly 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.

In this case, the Department’s audit staff requested information to substantiate the deductions and expenses within one year of the adjustments made to the returns. The adjustments were made on September 24, 2020. As such, the requested documentation would need to be provided to the Department by September 24, 2021.

The auditor who audited your returns is no longer with the Department. As such, the Taxpayers must send the additional information to the Office of Compliance, Desk Audit, RAP, P.O. Box 5610, Richmond, Virginia 23220-0610, Attention: *. Any questions regarding the requested information should be directed to at **.

The audit staff will review the documentation once it is received, adjust the assessments as warranted and notify the Taxpayers of the results of the review. If the Taxpayers still disagree with the results, they may file an appeal within 90 days of the date they are notified. If the documentation is not submitted within the time allotted, the assessments will be considered to be correct and collections actions will resume.

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 determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3627.B