The IRS accepted my charitable and business expense deductions without question -- can Virginia still disallow them on audit for lack of documentation?

Plain-English summary

A Virginia resident filed state income tax returns for 2019 through 2021. During an audit, the Department asked him to substantiate two things: charitable contributions claimed on his 2019 federal Schedule A, and business expenses claimed on his 2020 and 2021 federal Schedule Cs (sole proprietorship income/loss). He never responded with documentation, so the Department disallowed both the charitable deduction and the business expenses, and separately capped his 2019 state-and-local-tax itemized deduction at $5,000 (the married-filing-separately limit under the federal SALT cap). Assessments followed. His appeal argument: only the IRS has the authority to disallow deductions claimed on a federal return -- not Virginia.

The Department rejected that argument on clear statutory grounds. Virginia income tax generally conforms to federal concepts and starts its computation from federal adjusted gross income (Va. Code § 58.1-301) -- but that conformity doesn't mean the Department has to accept whatever numbers show up on a federal return without question. Va. Code § 58.1-219 specifically gives the Department authority to independently adjust federal AGI and itemized deductions where there's clear evidence the reported amounts aren't actually consistent with the Internal Revenue Code -- and the Department cited a string of prior cases (P.D. 10-126, 12-141, 14-155, 16-53, 19-104, 21-67) showing it has exercised this authority repeatedly, independent of anything the IRS does.

Each disallowed item had its own basis:

• Business expenses (Schedule C): IRC § 162 allows deducting ordinary and necessary business expenses, but the taxpayer provided zero documentation when asked, so the deduction was disallowed entirely.
• Charitable contributions: Va. Code § 58.1-322.03 1 allows the state deduction to track the federal itemized deduction, but deductions for charitable contributions (like property taxes and other itemized items) are only allowable when payment can be substantiated with receipts or cancelled checks (P.D. 14-155, P.D. 19-78) -- again, nothing was provided.
• State and local tax deduction: The federal Tax Cuts and Jobs Act capped this deduction at $10,000 ($5,000 for married filing separately), and Virginia generally conformed to that cap (VTB 19-1), so the Department reduced the taxpayer's claimed deduction to the applicable $5,000 limit.

Burden of proof cut decisively against the taxpayer. Under Va. Code § 58.1-205, a Department assessment is presumed correct, and the taxpayer bears the burden of proving otherwise. Virginia law even bars a court from granting relief where an erroneous assessment stems from the taxpayer's own willful failure to provide required information (Va. Code § 58.1-1826). Still, the Department wasn't fully final: it gave the taxpayer one last 30-day window to submit proper documentation to a specific auditor before the assessments would be considered correct and unappealable further.

What this means for you

Anyone who assumes the IRS's acceptance of a deduction means Virginia can't question it

This ruling makes clear that isn't true. Virginia has its own independent statutory authority (Va. Code § 58.1-219) to adjust federal AGI and itemized deductions when there's clear evidence they don't match the IRC, entirely apart from whatever the IRS has or hasn't done.

Anyone claiming charitable contribution deductions

Keep receipts or cancelled checks for every contribution. This ruling reaffirms that substantiation by that kind of documentation -- not just the fact that you claimed it on your federal return -- is what the Department requires when it asks.

Sole proprietors claiming Schedule C business expenses

Maintain records connecting each expense to your trade or business (per IRC § 162 and Treas. Reg. § 1.162-1). A complete failure to respond to a documentation request, as happened here, results in the entire deduction being disallowed.

Married taxpayers filing separately and claiming state and local tax itemized deductions

Remember the federal SALT cap is $5,000 for each spouse filing separately (not the full $10,000), and Virginia has generally conformed to that limit.

Common questions

Q: If the IRS accepted my federal deductions without any changes, can Virginia still disallow them on a state audit?
A: Yes. This ruling confirms Va. Code § 58.1-219 gives the Department independent authority to adjust federal AGI and itemized deductions when there's clear evidence of an inconsistency with the IRC, regardless of any IRS action.

Q: What documentation do I need to support a charitable contribution deduction on my Virginia return?
A: Per this ruling and the prior rulings it cites, receipts or cancelled checks substantiating the payment -- a bare claim on your federal Schedule A isn't sufficient if the Department asks for proof.

Q: What's the SALT deduction cap for married taxpayers filing separately in Virginia?
A: $5,000 each, per the federal Tax Cuts and Jobs Act's $10,000 cap (split in half for separate filers), which Virginia generally conforms to per VTB 19-1.

Citations and references

Statutes and regulations:

• Va. Code § 58.1-301 -- Virginia tax terminology generally conforms to the Internal Revenue Code
• Va. Code § 58.1-219 -- the Department may independently adjust federal AGI and itemized deductions inconsistent with the IRC
• Va. Code § 58.1-322.03 1 -- allows a Virginia deduction for federal itemized deductions, including charitable contributions
• Va. Code § 58.1-310 -- the Department may require production of federal returns and supporting schedules
• Va. Code § 58.1-205 -- a Department assessment is prima facie correct; burden of proof is on the taxpayer
• Va. Code § 58.1-1826 -- courts cannot grant relief where an erroneous assessment stems from the taxpayer's willful failure to provide required information
• IRC § 162 -- deduction for ordinary and necessary business expenses

Prior rulings referenced (described here, not linked): P.D. 10-126 (7/7/2010), P.D. 12-141 (8/29/2012), P.D. 14-155 (8/28/2014), P.D. 16-53 (4/11/2016), P.D. 19-104 (9/18/2019), and P.D. 21-67 (5/25/2021) -- confirm the Department's independent authority to adjust federal-return items regardless of IRS action; P.D. 19-78 (7/29/2019) -- charitable/itemized deductions require documentary substantiation such as receipts or cancelled checks; Virginia Tax Bulletin 19-1 (2/15/2019) -- explains Virginia's conformity to the federal $10,000/$5,000 SALT deduction cap.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-114

Original ruling text

October 19, 2023

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 “Taxpayer”) for the taxable years ended December 31, 2019, through 2021.

FACTS

The Taxpayer filed Virginia resident income tax returns for the 2019 through 2021 taxable years. Under audit, the Department requested documentation to support charitable deductions claimed on Schedule A of the Taxpayer’s 2019 federal income tax return and business expenses reported on Schedule C of his 2020 and 2021 federal returns. When a response was not received, the Department disallowed the charitable and business expense deductions. The Department also adjusted the deduction that the Taxpayer claimed for state and local income tax paid on his 2019 Schedule A. As a result, assessments were issued. The Taxpayer appealed, contending that only the Internal Revenue Service (IRS), not the Department, has the authority to disallow the deductions and 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 .

Adjustment of Items Reported on Federal Returns

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. The Department has consistently exercised this authority in conducting its audit programs. See Public Document (P.D.) 10-126 (7/7/2010), P.D. 12-141 (8/29/2012), P.D. 14-155 (8/28/2014), P.D. 16-53 (4/11/2016), P.D. 19-104 (9/18/2019), and P.D. 21-67 (5/25/2021). The adjustments in these cases may be made independently from any actions taken by the IRS.

Business Expenses

Under IRC § 162, taxpayers are permitted to deduct all of the ordinary and necessary business expenses paid or incurred during the taxable year in carrying on any trade or business. Such expenses must be directly connected with or pertaining to the taxpayer’s trade or business. See Treas. Reg. § 1.162-1.

Federal Form 1040 Schedule C is used to report income or loss from a business, including a sole proprietorship. Income from the business 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.

The Taxpayer claimed business expenses on his 2020 and 2021 federal Schedule Cs. As permitted by Virginia law, the Department requested that the Taxpayer provide documentation to substantiate his business expenses. Because the Taxpayer failed to provide any documentation, the deduction for the expenses was disallowed.

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. These deductions include those for real estate taxes, home mortgage interest, personal property taxes, medical expenses, and charitable contributions, provided they are claimed in accordance with the IRC and its related regulations.

The auditor requested that the Taxpayer provide documentation to verify the deduction for charitable contributions claimed on his 2019 return. The request clearly indicated the documentation required to substantiate his charitable contributions. Deductions for property taxes, charitable contributions, and other expenses are allowable only when payment can be substantiated through items such as receipts or cancelled checks. See P.D. 14-155 (08/28/2014) and P.D. 19-78 (7/29/2019). The Department disallowed the charitable deduction claimed on the Taxpayer’s 2019 return because sufficient documentation was not provided.

State and Local Tax Deduction Adjustment

Under the federal Tax Cuts and Jobs Act, (Public Law) 115-97 (12/22/2017) (the “TCJA”), a $10,000 limit ($5,000 for married individuals filing separately) for the state and local tax deduction was imposed. See Virginia Tax Bulletin (VTB) 19-1 (2/15/2019). Virginia generally conformed to the TCJA, including this provision. The Department, therefore, reduced the Taxpayer’s state and local tax deduction to $5,000 on his separate 2019 Virginia individual income tax return.

CONCLUSION

Taxpayers must maintain records sufficient to allow the IRS to determine their correct tax 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 properly to 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.

Under the provisions of Virginia 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 that the assessment was erroneous. Further, Virginia Code § 58.1-1826 precludes a court from granting relief to taxpayers seeking correction of erroneous state tax assessments in cases in which the erroneous assessment is attributable to the taxpayer’s willful failure or refusal to provide the Department with necessary information as required by law.

I will, however, allow the Taxpayer one final opportunity to provide adequate documentation to substantiate the deductions that were disallowed. The documentation must be sent to the Virginia Department of Taxation, RAP Unit, Office of Compliance, Desk Audit, RAP, P.O. Box *, Richmond, Virginia 23220-0610, to the attention of the auditor, ***, within 30 days of the date of this letter. Based on the documentation provided, the assessments will be adjusted as warranted. If the documentation is not received within the allotted time, the assessments will be considered to be correct.

The Code of Virginia sections, Tax Bulletin and public documents 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 (804) ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/4585.B

Related Documents

10-126

12-141

14-155

16-53

19-1

19-104

21-67