Can Virginia disallow federal Schedule C business-expense deductions and uphold an income tax assessment when a taxpayer under audit fails to provide documentation to support those deductions?

Plain-English summary

A married couple (referred to throughout as "the Taxpayers") filed Virginia resident income tax returns for the 2023 and 2024 taxable years that claimed deductions on federal Schedule C, the form used to report profit or loss from a sole proprietorship business. When the Virginia Department of Taxation audited the returns, it asked the Taxpayers to provide documentation supporting those Schedule C deductions. The Taxpayers never responded. Because the deductions could not be verified, the Department disallowed them and issued assessments for additional tax. The Taxpayers then applied for correction of the assessments, arguing that the Department had no authority to second-guess or adjust amounts they had reported on their federal Schedule C.

The Tax Commissioner rejected that argument. Virginia individual income tax starts with federal adjusted gross income (FAGI) as the computation base, and under Va. Code § 58.1-301 Virginia generally borrows federal tax terminology and concepts unless the state law clearly requires something different. While the Department ordinarily accepts the numbers reported on a taxpayer's federal return at face value, it is not required to do so blindly. Under Va. Code §§ 58.1-219 and 58.1-310, the Department may examine and adjust FAGI and itemized deductions whenever there is clear evidence that the amounts reported are inconsistent with the Internal Revenue Code -- and it can do this even independent of any action by the IRS itself. The ruling lists a long line of prior public documents (P.D. 10-126, P.D. 12-141, P.D. 14-155, P.D. 16-53, P.D. 19-104, P.D. 21-67, and P.D. 22-11) showing the Department has consistently exercised this authority.

The ruling also walks through why the burden fell on the Taxpayers, not the Department, to prove their deductions were valid. Federal law (Treas. Reg. § 1.6001-1(a)) already requires taxpayers to keep records sufficient to substantiate their reported tax liability, and Virginia law independently gives the Department the right to demand copies of federal returns and supporting schedules under Va. Code § 58.1-310. On top of that, Va. Code § 58.1-205 makes any Department assessment "prima facie correct," meaning the taxpayer bears the burden of proving it wrong. Because the Taxpayers never supplied any documentation at all, they could not meet that burden, and the ruling notes that Va. Code § 58.1-1826 separately bars courts from granting relief where an erroneous assessment traces back to the taxpayer's own willful failure to provide required information.

Given all of this, the Tax Commissioner upheld the assessments for both the 2023 and 2024 taxable years. However, the ruling was not the final word: the Department gave the Taxpayers one last 30-day window from the date of the letter to submit the missing documentation to the Office of Compliance, Desk Audit, RAP. If documentation is submitted and accepted, the assessments could still be adjusted; if nothing is submitted in time, the assessments become final and the Taxpayers will receive updated bills with accrued interest, due within 30 days to avoid further interest and possible collection action.

What this means for you

If you are a self-employed taxpayer or sole proprietor under audit

Filing a Schedule C does not put your reported deductions beyond the Department's reach. Virginia can and routinely does examine and adjust federal-return figures -- including Schedule C business expenses -- whenever it has clear evidence the numbers are inconsistent with the Internal Revenue Code. Keep contemporaneous, organized records (receipts, mileage logs, invoices, bank and credit card statements) for every deduction you claim, because you may be asked to produce them years later during an audit, and the law places the burden of proof on you, not the Department.

If the Department asks you for documentation during an audit

Respond, and respond within the deadline given. This ruling turned entirely on the fact that the Taxpayers never furnished any records at all -- not on a dispute over whether their expenses were legitimate. An assessment is presumed correct once issued, and Virginia law bars courts from granting relief when an erroneous assessment stems from the taxpayer's own willful failure to provide required information. If you receive a document request, even a partial or late response is generally better than silence, and this ruling shows the Department will sometimes offer one final opportunity (here, 30 days) to submit records before an assessment becomes final.

If you disagree with the Department's authority to adjust your return

Arguing that the Department cannot look behind your federal Schedule C numbers is unlikely to succeed on its own. Virginia's conformity to federal terminology (Va. Code § 58.1-301) does not strip the Department of its statutory audit authority under §§ 58.1-219 and 58.1-310. A correction request built solely on a jurisdictional objection, without accompanying substantiation of the underlying deductions, does not overcome the presumption that an assessment is correct.

Common questions

Does filing a valid federal Schedule C automatically mean Virginia has to accept my deductions?
No. The Department generally relies on federal return figures when they appear reasonable, but it retains authority under Va. Code §§ 58.1-219 and 58.1-310 to examine and adjust FAGI and itemized deductions whenever there is clear evidence the reported amounts are inconsistent with the Internal Revenue Code -- and it can do so independent of the IRS.

Who has the burden of proof once Virginia issues an assessment?
The taxpayer does. Under Va. Code § 58.1-205, any Department assessment is deemed prima facie correct, meaning the taxpayer must affirmatively establish that it is wrong.

What happens if I never respond to the Department's request for records?
The Department will disallow the unsupported deductions and issue (or uphold) an assessment. Va. Code § 58.1-1826 further prevents a court from granting correction relief where the erroneous assessment resulted from the taxpayer's own willful failure to provide required information.

Is there still a chance to fix the assessment after a ruling like this is issued?
Sometimes. In this case, the Department gave the Taxpayers a final 30-day window from the date of the letter to submit documentation to its Office of Compliance before the assessments would be treated as final and updated bills (with accrued interest) issued.

Citations and references

• Va. Code § 58.1-1821 (application for correction of individual income tax assessment)
• Va. Code § 58.1-301 (Virginia's use of Internal Revenue Code terminology and conformity)
• Va. Code § 58.1-219 (Department's authority to adjust FAGI and itemized deductions)
• Va. Code § 58.1-310 (Department's right to require federal returns and supporting schedules)
• Va. Code § 58.1-205 (assessments deemed prima facie correct; burden of proof on taxpayer)
• Va. Code § 58.1-1826 (bar on court relief where erroneous assessment stems from taxpayer's willful failure to provide information)
• Treas. Reg. § 1.6001-1(a) (federal recordkeeping requirement to substantiate tax liability)
• P.D. 10-126 (07/07/2010), P.D. 12-141 (08/29/2012), P.D. 14-155 (08/28/2014), P.D. 16-53 (04/11/2016), P.D. 19-104 (09/18/2019), P.D. 21-67 (05/25/2021), and P.D. 22-11 (01/18/2022) -- prior rulings cited as consistent precedent for the Department's audit-adjustment authority

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 26-49

Original ruling text

May 26, 2026

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will respond to your letter in which you seek correction of the individual income tax assessments issued to you (the “Taxpayers”) for the taxable years ended December 31, 2023 through 2024.

FACTS

The Taxpayers filed Virginia resident income tax returns for the 2023 through 2024 taxable years claiming deductions on federal Schedule C. Under audit, the Department requested documentation to support the deductions. When no response was received, the Department disallowed the deductions and issued assessments. The Taxpayers applied for correction, contending the Department lacks the authority to adjust amounts reported on Schedule C.

DETERMINATION

Virginia Code § 58.1-301 provides, with certain exceptions, that the 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 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 .

Generally, 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 appears reasonable, then, typically, the Department does not look behind those computations. The Department, however, may examine and adjust the FAGI and itemized deductions where there is clear evidence that the amounts reported on the federal or Virginia income tax return are inconsistent with the IRC. See Virginia Code § 58.1-219 and § 58.1-310. The Department has consistently exercised this authority in conducting its audit programs. See Public Document (P.D.) 10-126 (07/07/2010), P.D. 12-141 (08/29/2012), P.D. 14-155 (08/28/2014), P.D. 16-53 (04/11/2016), P.D. 19-104 (09/18/2019), and P.D. 21-67 (05/25/2021). In addition, such adjustments have been made independently from any actions taken by the IRS. See P.D. 22-11 (1/18/2022).

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.

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 Taxpayers to establish that the assessment is incorrect. 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.

Because the Taxpayers failed to furnish information required by law, the Department must uphold the assessments for the 2023 through 2024 taxable years. The Department will, however, give the Taxpayers one last opportunity to provide adequate documentation. The documentation should be submitted within 30 days from the date of this letter to: Virginia Department of Taxation, Office of Compliance, Desk Audit, RAP, P.O. Box 5610, Richmond, Virginia 23220-0610, Attention: *, Tax Auditor. Upon receipt, the documentation will be reviewed, and the assessments may be adjusted, as appropriate. If the documentation is not received within the allotted time, the assessments will be considered correct. In either case, the Taxpayers will receive updated bills that will include accrued interest to date. The Taxpayers should remit the balance due within 30 days of the bill dates to avoid the accrual of additional interest and possible collection actions.

The Code of Virginia sections cited are available online at law.lis.virginia.gov. The public documents cited are available at tax.virginia.gov in the Laws, Rules, & Decisions section of the Department’s website. If you have any questions regarding this determination, you may contact * in the Office of Legal Affairs, Tax Adjudication and Resolution Division, at or **.

Sincerely,

Kristin L. Collins
Tax Commissioner
Commonwealth of Virginia

AR 5353.J

Related Documents

10-126

12-141

14-155

16-53

19-104

21-67

22-11