Tax audits are all about verifying the information you provide or omit from a tax form. When income and expenses cannot be confirmed or are missing, the IRS or New York State Tax Department can make their own estimates, which often means you end up owing a lot more money than if you could support your own figures. In addition, if the IRS and New York State find that you owe back taxes, they can charge you penalties and interest as well as take various collection actions and even go after you criminally.
As a result, if you receive an audit notice, one of the first things you should do is gather your financial records. Good financial record-keeping is one of the best ways to help your case in the event of an audit.
In a typical audit, agents will examine a vast array of financial records, including bank statements, bills, receipts, past tax returns, W-2s, 1099s, sales records, company ledgers (if the taxpayer is a business) and other evidence of income and expenses. The documentation varies depending on the reason for the audit. For example, in a New York State residency audit where there is a question as to how much time the taxpayer spent within New York State, taxpayers may have to show credit card statements, phone bills, cellphone and E-Z Pass records, personal appointment calendars, building swipe card records, mobile apps that track and record your location and other information that may prove where they were located on a given day.
When it comes to businesses, record-keeping is even more critical. The IRS website provides guidance to businesses on what records they need to keep and for how long. New York State also has its own rules for businesses. For example, businesses who collect sales tax must meet strict requirements, such as sequentially numbering and dating records, maintaining checks and cash register tapes and details describing the taxable (or non-taxable) nature of each item sold. As with individual taxpayers, where a business does not have proper records, the law allows the auditor to estimate the business’s tax bill using various indirect methods. In other words, because your business cannot prove what your actual purchases and sales were, the auditor can make an educated guess and then hand you a bill assessing tax, plus penalties and interest. The business then bears the burden of proving that the auditor’s projected tax assessment is erroneous. As noted, penalties and interest may be imposed, plus the business may have its Certificate of Authority revoked or face criminal prosecution for failure to pay. There is also a separate penalty for failing to make or maintain records or make them available to the New York State Tax Department.
Responding to an audit is time-consuming, expensive and invasive. The more organized and accurate your financial records, the easier (and less expensive) it will be for you and your attorney to deal with an audit. If you do get audited, these records will be needed to prepare and respond to the audit. They can also provide justification for more lenient treatment of tax delinquencies, such as proving you are a good candidate for an installment plan, offer in compromise, penalty abatement or another resolution.
If you’ve been notified of an audit, your first instinct may be to panic or pretend you didn’t get it, but that’s the worst thing to do. Not responding to a notice will only magnify tax problems. It is far better to face the problem and work out a resolution. You should start putting together your financial records and contact an experienced tax attorney for assistance.
Karen Tenenbaum, Esq., LL.M. (Tax), CPA is founder and a managing partner of Tenenbaum Law, P.C. (www.litaxattorney.com), a tax law firm in Melville, which focuses its practice on the resolution of IRS and New York State tax controversies. She can be reached at firstname.lastname@example.org or 631-465-5000.