I argued my wages aren't legally 'income' and that the federal income tax is really just an excise tax that doesn't reach my earnings -- does that get my Virginia assessment thrown out?

Plain-English summary

A married couple filed Virginia resident returns for 2017 and 2018. The IRS later told the Department it had adjusted the couple's federal adjusted gross income (FAGI) for both years after finding their income had been underreported. Because the couple never filed amended Virginia returns to reflect those federal corrections, the Department -- using the IRS-supplied figures, which federal law specifically authorizes it to obtain when a taxpayer doesn't self-report a federal change -- assessed additional Virginia tax and interest for both years.

On appeal, the couple didn't dispute the numbers; instead, they argued their wages weren't legally "income" subject to tax, and separately that the federal income tax is actually an excise tax that only applies to certain federally-connected receipts, not ordinary earnings. These are two of the most well-known tax-protester theories in American tax law, and the Department flatly rejected both, citing federal court decisions that have repeatedly and specifically rejected each argument as meritless.

Importantly, the Department noted that Virginia's tax on the couple didn't even depend on winning that federal argument. Virginia's income tax computation starts from federal adjusted gross income as a matter of administrative convenience, but Virginia's actual AUTHORITY to tax its own residents comes from the Commonwealth's own inherent sovereign power to tax -- not from the U.S. Constitution or from how the Internal Revenue Code happens to define "income." Since the couple were Virginia residents, their income was taxable by Virginia regardless of any argument about federal tax theory. The assessments for both years were upheld, and the Department went out of its way to warn that filing a return based solely on this kind of "wages aren't income" theory is treated as an intentional understatement of tax liability with intent to evade tax -- which carries a 100% fraud penalty under Virginia law.

What this means for you

Anyone tempted by "wages aren't taxable income" or "income tax is just an excise tax" arguments

Don't. These theories have been rejected by courts for decades and carry real teeth in Virginia: filing a return (or refusing to correct one) based solely on this kind of argument is treated as an intentional attempt to evade tax, triggering a 100% fraud penalty on top of the tax and interest you'd owe anyway.

Anyone whose federal return was adjusted by the IRS and who hasn't told Virginia

File an amended Virginia return within a year of the federal change becoming final. If you don't, the Department can (and routinely does) get the adjusted figures directly from the IRS and assess you based on that information -- with no need for your cooperation or agreement.

Anyone wondering why Virginia's income tax depends on federal tax definitions

It's a matter of administrative convenience, not constitutional necessity. Virginia's actual power to tax its residents comes from its own inherent state sovereignty; using federal adjusted gross income as the starting computation point doesn't limit or condition that independent state authority in any way.

Common questions

Q: Can I argue my wages aren't legally "income" to avoid Virginia income tax?
A: No. Courts have consistently and repeatedly rejected this argument as meritless, and Virginia's Department of Taxation treats it the same way -- with an added warning that basing a return on it can trigger a 100% fraud penalty.

Q: Is Virginia's power to tax me dependent on the federal government's definition of income tax?
A: No. Virginia has its own inherent, independent power to tax its residents, separate from the U.S. Constitution or how the IRC defines income. Starting the Virginia computation from federal adjusted gross income is just an administrative convenience, not a constitutional limitation on the state's own taxing authority.

Q: What happens if the IRS adjusts my federal income and I don't tell Virginia?
A: The Department can obtain your adjusted information directly from the IRS under federal information-sharing law and assess the resulting Virginia tax and interest -- you don't need to cooperate or agree for this to happen.

Q: What's the risk of filing a return based on a "wages aren't income" or similar theory?
A: Beyond the assessment being upheld, Virginia treats an intentional understatement of tax liability based on such an argument as tax evasion, subject to a 100% fraud penalty under Va. Code § 58.1-308.

Citations and references

• Va. Code § 58.1-301 (Virginia's income tax computation begins with federal adjusted gross income, per fixed conformity to the IRC)
• Va. Code § 58.1-311 (a federal taxable income change must be reported to Virginia within 1 year via an amended return)
• IRC § 6103(d) (authorizes the IRS to share taxpayer information with state tax agencies)
• Va. Code § 58.1-302 (definition of a Virginia resident subject to Virginia income tax)
• Va. Code § 58.1-308 (100% fraud penalty for an intentional understatement of tax liability with intent to evade)
• Broughton v. United States, 632 F.2d 706 (1980) (the "wages are not income" argument is without merit)
• George J. Smith, et ux., T.C. Memo 2019-111 (the "income tax is merely an excise tax" argument is without merit)
• Colonial Pipeline Co. v. Commonwealth of Virginia, 206 Va. 517, 145 S.E.2d 227 (1965) (Virginia's taxing power is inherent and not derived from the U.S. Constitution)
• New York ex rel. Cohn v. Graves, 300 U.S. 308 (1937) (a resident's receipt of income is a universally recognized taxable event)

Subject

Federal Adjusted Gross Income: Wages - No Basis to Exclude Wages from FAGI

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-83

Original ruling text

April 28, 2022

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, and 2018.

FACTS

The Taxpayers filed Virginia resident individual income tax returns for the 2017 and 2018 taxable years. The Department received information from the Internal Revenue Service (IRS) indicating the IRS adjusted the Taxpayers’ 2017 and 2018 federal adjusted gross income (FAGI). The Department’s records, however, indicated the Taxpayers had not filed amended Virginia returns to report the federal changes. As a result, the Department issued assessments for additional tax and interest. The Taxpayers appeal, asserting that their earnings are not subject to income tax.

DETERMINATION

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 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 .

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 one year 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 Taxpayers’ income had been underreported for the 2018 and 2019 taxable years and their FAGI had been adjusted accordingly. Because Virginia’s taxable income begins with FAGI, the Virginia return was properly adjusted based on federal information obtained under IRC § 6103(d).

The Taxpayers contend that their wages do not qualify as income for purposes of the federal income tax. Courts have consistently held that the argument that wages are not income is without merit. See, e.g., Broughton v. U.S., 632 F.2d 706 (1980). Further, the Taxpayers contend that the federal income tax is actually an excise tax and thus is not a tax on all earnings, rather it is specific to receipts of a federal nature. Courts have also held that this argument is without merit. See, e.g., George J. Smith, et ux. , TC Memo 2019-111.

In addition, 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, 145 S.E.2d 227 (1965). Thus, the mere fact that Virginia starts with terms defined in the IRC to determine Virginia taxable income does not in any way inhibit the Commonwealth’s authority to impose an income tax on its citizens.

Further, 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 Virginia Code § 58.1-302. As stated above, income properly included in the FAGI of a Virginia resident is subject Virginia taxation unless specifically exempt as a modification pursuant to Chapter 3 of Title 58.1 of the Code of Virginia . Accordingly, the Taxpayers’ argument that their income is not subject to Virginia taxation has no basis in fact or Virginia law. An individual who fails to file correct Virginia income tax returns based solely on such claims has intentionally understated his income tax liability with the intent to evade tax and is subject to a 100% fraud penalty pursuant to Virginia Code § 58.1-308.

Therefore, the assessments for the 2017 and 2018 taxable years are upheld. The Taxpayers will receive an updated bill that will include accrued interest to date. The Taxpayers should remit the balance due within 30 days of the bill date to avoid the accrual of additional interest and the initiation of collection actions.

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/4088.X