Introduction to Tax Audits

A tax audit is an official inspection of an individual’s or organization’s tax returns and financial information to determine if income, expenses, deductions, and credits are reported correctly and in compliance with tax laws. Audits help maintain the integrity of the tax system by discouraging fraud and ensuring that all taxpayers pay their fair share.

Audit Selection: Why Are Taxpayers Chosen?

IRS Audit Selection

• Random Selection: A portion of returns is randomly chosen each year for review. This helps ensure ongoing tax compliance across the population.
• Computer Screening: The IRS deploys sophisticated programs that score each tax return against statistical norms for similar filers. Significant deviations can trigger audits.
• Document Matching: Returns are matched with third-party forms (such as W-2s and 1099s) to uncover unreported income or other discrepancies.
• High-Risk Areas and Red Flags: Large deductions, business expenses inconsistent with reported income, certain credits, or being a high-income taxpayer can increase audit likelihood.

NYS Audit Selection

• Failing to file required returns.
• Failing to report all income or sales.
• Claiming excessive credits, refunds, or exclusions.
• Filing incorrect or fraudulent returns.
• Discrepancies uncovered through comparison with other data sources, including the IRS, banks, and employers.
• Patterns from previous audits (although prior audits don’t automatically trigger future reviews).

Notification: How You’ll Know You’re Being Audited

IRS Notification

The IRS will never call, text, or email to initiate an audit. Instead, an official notice arrives by postal mail, stating the reason for the audit, whether it’s a correspondence (mail), office, or field audit, and what records or documents are required.

NYS Notification

Similar to federal audits, NYS always notifies taxpayers by mail, outlining the type of tax being audited, the years or periods under review, and a request for specific records with a deadline for providing documents, usually 30 to 35 days from the mailing date. Failing to respond can result in an automatic adjustment or penalties, so prompt action is required.

Examination: What Happens During the Audit

IRS Audit Procedures

• Correspondence Audits: Handled by mail and limited to specific issues. Typically require sending copies of receipts, statements, or explanations.
• Office Audits: Conducted in an IRS office, these are broader and may involve questions about the return and supporting documentation.
• Field Audits: Done at the taxpayer’s home, place of business, or accountant’s office. These are the most comprehensive audits.

The IRS may review financial accounts, request additional documents, and interview taxpayers. After examination, the auditor provides a report explaining proposed adjustments, if any.

NYS Audit Procedures

• Requesting supporting documentation for income, credits, deductions, sales, and exemptions claimed.
• Conducting interviews, especially during residency or sales tax audits.
• Using questionnaires or multiple rounds of document requests, particularly to establish residence, business activity, or eligibility for credits.

At the end of the audit, NYS may issue a bill for additional tax, deny credits or refunds, propose a refund, or find no changes necessary.

Common Audit Triggers and High-Risk Areas

IRS Red Flags

• High incomes, especially over $400,000 or with multiple income streams.
• Unusually large charitable deductions.
• Complex business expenses or higher-than-typical home office claims.
• Inconsistencies between reported and third-party information.
• Frequent or substantive changes in income, deductions, or credits claimed year over year.

NYS Red Flags

• Significant differences between federal and state returns.
• Unreported sales or income.
• Excessive or unusual business expenses compared with industry norms.
• Residency issues, especially if a taxpayer claims nonresident or part-year resident status.

Your Rights During an Audit

• The right to understand why information is requested and how it will be used.
• The right to confidentiality and respectful treatment.
• The right to representation (e.g., by a CPA or attorney).
• The right to appeal or dispute findings.

Conclusion of the Audit

• No Change: If everything checks out, no action is needed.
• Agreed Changes: If you agree with proposed changes, you can sign the report and arrange to pay any additional tax owed, or receive a refund if overpaid.
• Disagreed Changes: If you disagree, you have the right to appeal the findings.

Appeals: Challenging Audit Results

IRS Appeals Process

• File a Written Protest: Submit a formal protest detailing your disagreement with supporting evidence, typically within 30 days of receiving the audit findings.
• Appeals Hearing: The Office of Appeals conducts a hearing—by mail, phone, or in person—to review both sides and seek resolution without litigation.
• Further Action: If unresolved, taxpayers may pursue mediation or take the issue to U.S. Tax Court. A simplified “small case” option is available for disputes involving less than $25,000.

NYS Appeals Process

• Request a Conciliation Conference within the NYS Tax Department, an informal process to resolve disagreements.
• File a petition with the Division of Tax Appeals for a formal hearing before an administrative law judge.
• Seek further review by the state Tax Appeals Tribunal and, if necessary, the state court system.

Be aware of strict deadlines for each step. Missing them can make assessments final, with penalties and interest accruing.

Key Strategies to Prepare and Respond

• Keep accurate, organized records for at least three years.
• Respond promptly and thoroughly to all audit requests.
• Consult with a trusted tax professional or attorney, especially for complex cases or if you plan to appeal.

Final Thoughts

Understanding IRS and NYS audit procedures—how cases are selected, how notifications are delivered, the examination steps, and the appeals process—puts taxpayers in a better position to respond calmly, efficiently, and successfully when under scrutiny. If you face an audit, act quickly, communicate transparently, keep thorough records, and seek professional support when needed. Your rights are protected, and careful preparation makes the process far less daunting.