New York State Tax Audit and Investigation

The NY Department of Taxation and Finance (DTF) can select any return for an audit, and if you're selected, you will need to back up all of the claims on your return, potentially even including your state residency status. Dealing with a New York State tax audit can be stressful and scary, and in a lot of cases, it also leads to additional tax liabilities. To help you out, this post explains what to expect during a NY state audit, how to appeal if you disagree with the results, how to pay unexpected tax liabilities, and related topics. It also looks at when and why you should engage a tax pro to help you.

In the last couple of years, New York State has been sending out more audit requests than usual. For instance, in the first nine months of 2021, the NY DTF sent out nearly 150,000 audit notices. The next year the number was even higher--the DTF reports that they did over 750,000 audits for tax years 2022 to 2023, leading to claiming over $3.2 billion in additional tax liabilities. The state usually only audits people and businesses with over a million dollars in income, but recent audit notices have been targeting people who earn between $100,000 and $300,000. Regardless of how much you earn, you could be audited.

Are you being audited by the New York Department of Taxation and Finance? Worried that you might be audited? Then, you need to reach out for help from a tax professional. In the meantime, check out this guide we've created a guide on what to expect during a NY state tax audit. 

What to Expect During a New York State Audit

During an audit, the taxing authority asks you to back up the information on your tax return. Here is an overview of the New State audit process:

1. The New York Department of Taxation and Finance selects tax returns to audit.
2. The Department contacts the taxpayer about the audit, usually with a letter through the mail.
3. The taxpayer gives the auditor information to back up the claims on their tax return. For example, if the auditor wants to see proof of your business deductions, you may send in bank statements and receipts.
4. The auditor reviews the information and decides whether or not to make changes to the return. 
5. If the changes lead to a refund, the NYDTF sends the refund to the taxpayer. If the changes lead to a tax bill, the DTF sends a letter about the proposed changes and waits for the taxpayer to respond. 
6. If the taxpayer agrees with the changes, they don't need to do anything. But if they disagree, they must explain why.
7. The auditor will review their response if relevant. If the auditor disagrees with the taxpayer or if the taxpayer doesn't respond, the auditor will issue a notice of deficiency.
8. The notice of deficiency will show how much the taxpayer owes, and it will note a 90-day deadline to appeal.
9. If the taxpayer agrees with the changes, they can pay the bill or try to make payment arrangements with the state. If they disagree with the bill, they can appeal.

As you can see, the basic premise of an audit is simple. The NY DTF says, "Hey, we need proof of this information you reported on your tax return." Then, you send the proof, and the auditor reviews the materials and decides whether to make changes or not. 

The point of an audit is to assess compliance. For instance, a sales tax audit looks at sales tax compliance for NY businesses. 

However, whether you're dealing with a sales tax audit or any other type of audit, it can be a lot more complicated than it sounds. If you don't have the right paperwork, if you made a mistake on your return, or if you disagree with the auditor on how to interpret the tax law, the situation can get a lot more complicated. That's why you need a tax professional to help you with the audit. Their in-depth understanding of tax law can be critical

Responding to the Results of a NY State Tax Audit 

After the auditor has reviewed all of the information you have provided, they will conclude the audit. In some cases, the auditor won't make any changes to your state tax return. This is called a no-change audit. In most cases, the auditor will make changes also called audit adjustments, and then, you get to decide if you agree with the changes or not. The steps you should take vary based on whether or not you agree with the changes.

If you agree with the results of the audit, you can sign the Statement of Proposed Audit Changes. At that point, the new tax liability is due in full. If you can't afford to pay the tax bill, you can explore one of these options:

• Request an NYS payment plan — This allows you to make monthly payments on your tax debt. Check out the link for more details on how to set up a payment plan for your state taxes. 
• Apply for an offer in compromise — If you can't afford to pay the full tax liability from the audit adjustment, you may be able to settle for less than you owe. Check out the requirements and expectations in the link. 
• Look into innocent spouse relief — In rare cases where the additional tax liability was due to your spouse, you may qualify for innocent spouse relief. A tax pro can help you learn more about this program. There are a few different options depending on the situation.

What if you don't agree with the results of the state audit? Then, you can contest and appeal. Find the areas where you disagree on the Statement of Proposed Audit Changes, and mark your disagreements. Then, send the form back to the address noted on it. Also, send any documents you can to back up your claims. When dealing with an audit conclusion, you need to use clear and convincing evidence. 

The auditor will review the details you sent, and then, they will send you a revised copy of the proposed change. If you don't agree with the changes this time around, the auditor will move on and send you a Notice of Determination or Notice of Deficiency. This is the formal assessment of the taxes, and now, your taxes are due. You can give up and pay the tax liability, but ideally, you shouldn't give up yet. You still have the ability to formally appeal. 

Appealing a NY Tax Audit

To appeal the audit, you need to go through the Tax Department's Bureau of Conciliation and Mediation Services or through the Independent Division of Tax Appeals. If you're dealing with estate taxes, you should go through the Bureau of Conciliation and Mediation Services or through the surrogate court for your county. 

You must appeal within 90 days of receiving the notice. Note that this deadline is 90 days from the date you receive the Notice of Deficiency or Notice of Determination. The timeline does not start with the Notice of Proposed Changes. You have to appeal in writing. If you're not sure how to handle this, a tax professional can help you. 

Keep in mind that the response to the Proposed Changes is not the same as an appeal. Say that you wrote out a response when you first received the proposed changes, and the auditor rejected your claims and moved forward with the Notice of Deficiency. You can't use your original response as the appeal. You must write a new response, even if you're going to use the same reasons. Submitting your appeal by the 90-day deadline is critical. If you miss this deadline, you may not be able to appeal.

Reasons For New York Income Tax Audits

In the past, the NY DTF selected most returns for audits randomly. Now, the department primarily relies on software to identify returns for audits. The DTF's Case Identification and Selection System (CISS) uses thousands of different processes to look for potential issues. The CISS allows the state to target returns based on specific criteria, but it's important to note that some returns are still selected randomly for audits. Any NY tax return may be selected for audit.

Here are some of the reasons you may be chosen for a New York state income tax audit:

• Not reporting sales or income.
• Failing to file a return.
• Claiming excessive credits.
• Misusing exemption certificates.
• Making incorrect or fraudulent refund claims.
• Reporting different amounts than shown on tax forms from other entities — for instance, if the income on your tax return doesn't match the income shown on the W2 from your employer.

The DTF is actively working on improving its detection of tax fraud. In addition to CISS, the DTF also created the Fraud Analysis and Selection Team (FAST) which includes two supervisors and seven staff members. FAST looks for large-scale refund fraud schemes by looking for returns for the same paid preparer, returns filed from the same IP address, redundant or fake mailing addresses, common bank accounts, similar refund amounts, repetitive claims, and other signs of refund fraud. Once the system discovers a refund scheme, it goes on the hunt for fraudulent returns that have similar preparers, IP addresses for submission, bank routing numbers, or Social Security numbers.

The DTF will continue investing in tools and staff members that help with the audit selection process because the process has a great return on investment for the agency. CISS required a $3.8 million investment, while the FAST staff costs about $600,000 per year and other costs bring the total to about $5.1 million. However, these tools allowed the DTF to collect over $151 million in unpaid taxes during the first three years after implementation.

Reasons for NY Residency Audits

In 2021, New York State also began taking a closer look at residency issues. In particular, the state audited a lot of returns with the following potential red flags 1) taxpayers living part of the year in New York, 2) returns from non-residents who work and perform services out of state, and 3) returns with a lot less New York-based income than previous years. 

Reasons for Sales Tax Audits in New York

The NY DTF uses different criteria for different types of audits. When choosing returns for sales tax audits, the state looks for the following issues:

• Significant differences between sales reported on income tax returns compared to sales reported on sales tax returns — The numbers don't need to be exactly the same, but they should usually be close.
• Aberrations between the percentage of taxable sales transactions to total sales on sales tax returns compared to the rates for similar businesses.
• Differences between other sales ratios compared to similar businesses. 
• Drastic changes in a business's filing patterns.
• Differences between information on returns and information reported by other entities. 

The DTF also looks at New York parking and speeding tickets that have been issued to businesses. Then, it checks to see if those businesses are filing income and sales/use tax returns. If you or one of your employees gets pulled over for speeding in a company car, your business may have a heightened risk of facing a sales tax audit. 

Types Of New York State Audits

The New York Department of Tax and Finance can audit any return that you submit to the agency. However, these are the most common types of audits in New York State:

• Income Tax Audits — These audits look into information reported on individual and corporate income tax returns. 
• Sales Tax Audits — These audits look at information reported on NY sales and use tax returns.
• Residency Audits — These audits are very comprehensive, and they assess if you are a resident of the state and when. New York residents must pay tax on all of their income regardless of where it was sourced from, but non-residents only need to pay tax on their NY-based income. Your residency status can have a significant impact on your NY state liability. These audits involve a thorough examination of your ties to New York State, including a domicile test and a statutory residency test, and this process allows the DTF to determine if you allocated the correct amount of your income to New York State. Auditors get very granular during these audits, looking at travel schedules, where you keep your pets, and other personal details.

Those are the most common types of New York State audits. Regardless of the type of return being audited, the audit may be conducted in a few different ways. Take a look.

• Correspondence Audit — These are usually the simplest audits. The NY DTF mails you a letter asking for more information. You send the supporting documents. The whole process happens through the mail. 
• Desk Audits — The NY DTF sends you an audit notice, and you set up a meeting to go to the auditor's desk which will happen at a DTF office somewhere near your business. Then, you bring in your supporting documents for the auditor to review. You may need multiple meetings to resolve the audit. 
• Field Audits — These audits happen in your home or at your place of business (usually the latter), but if you hire an attorney, the auditor may be willing to come to the attorney's office. They are called field audits because the auditor goes out in the field to meet with you. If possible, you may want to try to hold these audits in an attorney's office. as a neutral third space can sometimes be more convenient than your place of business.

When the NY DTF sends you the audit notice, it will explain what is being audited and the type of audit. For instance, it may say that you're facing a sales tax audit handled by correspondence. The notice will also have instructions on what type of information you need to provide to the auditor. 

How to Deal With a New York State Tax Audit

If you receive a New York State tax audit, you're probably wondering what to do. The audit notice should outline what the auditor wants to see, but it can still be very confusing to deal with an audit on your own. Here is an overview of what you should do when you receive an audit notice.

Respond to the Audit Request

Don't ignore the audit request. If you don't respond, the state may adjust your return without your input. Then, the DTF will send you a bill for any additional tax due to the changes. Once you get to this point, making changes is much harder. 

Gather Required Documents

Once you know what the auditor wants, start to gather the required documents. For instance, let's say that the auditor wants proof of the basis you reported for a property sale. You will need to find sale documents and repair invoices that prove the basis you reported was correct. Or imagine that the auditor wants proof of your business deductions. You will need to find receipts that back up the expenses you reported on your tax return.

Hire A Professional

If you're confused by the audit request, worried about tax fraud, or just don't want to deal with the NY DTF, you should hire a tax professional. They can help you find the right paperwork for the audit. They can also help to ensure that you don't miss any deadlines, and if the tax law comes into question, they can use their expertise to guide you.

You should definitely contact a professional if you want to appeal the results of an audit. Appealing a state tax audit can be a tricky process. A New York tax pro can help ensure that you make the best argument possible. The appeal stage is typically your last chance to make any changes to the audit results, and if it's not handled carefully, you may end up facing a tax liability that much higher than necessary. 

How To Reduce the Risk of a New York State Tax Audit

To reduce your risk of an audit, you should try to avoid red flags on your New York State tax returns. However, you should never avoid claiming a tax credit or taking a deduction just because you're worried about triggering an audit. Simply, make sure that you maintain adequate records. Then, if you are audited, having adequate records makes the process a lot easier. In the meantime, be aware that the following issues may draw extra attention to your return and possibly lead to an audit. 

Unusual or Excessive Business Expenses

Businesses are often more likely to get audited than individuals. Whether you report your business expenses on a Schedule C or on their own corporate or partnership return, be careful about claiming excessive expenses, and always keep copies of your records. 

Keep in mind that you're only allowed to write off expenses that you incurred in the process of running your business. You're not allowed to claim personal expenses as business expenses. The NY taxing agency looks for differences between the expenses reported on your return and costs reported for similar businesses. Then, if there's a significant difference, you may be selected for an audit. The Internal Revenue Service uses similar criteria. 

If all of your expenses are legitimate, you usually don't have anything to worry about. However, you should ensure that you have adequate records and notes to back up your claims. 

Charitable Donations

If you donate a significant portion of your income to charity or if it looks like you're overstating your charitable deductions, New York may choose your return for an audit. Make sure that you have a strong paper trail to support the donations you make. Keep a receipt for any cash gift that you give to a charity, as well as for any noncash item like clothes or furniture. When donating gifts over a certain threshold, make sure you get appraisals as required. 

Amended Tax Returns

Amending your tax return doesn't necessarily increase your risk of a New York state audit. However, tax authorities often give amended returns a second look. To be on the safe side, you may want to make sure that you file your original return accurately. Then, you don't have to worry about amending it. 

Partial Year Residency in New York

In recent years, auditors have started taking a closer look at New York State tax returns that show partial year residency. If you're only a resident for part of the year, you only have to pay NY state taxes on worldwide income for that part of the year. 

In contrast, if you were a resident for the whole year, you'd have to pay state taxes on worldwide income for the whole year. Mistakes with residency status cost the NY DTF a lot of money so they tend to follow up on this issue. If you claimed part-year residency status, just be prepared to back up your claim if you get audited. 

FAQs About New York State Audits

If you have questions about New York State audits, we want to provide you with the answers you need. Here are answers to some frequently asked questions. 

What triggers an NYS tax audit?

The NY DTF uses computers to scan tax returns for potential issues. Any return can be randomly selected for an audit, but generally, the system selects returns for audit when it sees trouble aberrations. Trouble aberrations are deviations from the norm that tend to signify a potential mistake or misstatement on a tax return. For example, this may include differences between the information on the return compared to the info submitted by other entities. It may be differences between one taxpayer's return and returns submitted by people/businesses in similar situations. Or it may be differences between your current return and a previous return.

How long does a NY state tax audit take?

A New York State audit can take up to a year or more, but in some cases, it can be completed in a couple of days. The length of time depends on the complexity of the return and whether or not the auditor and the taxpayer agree on things. 

For instance, sales tax audits are often faster than a full audit of a business tax return. That's simply because sales tax audits don't have to look into as much information as when you're dealing with a full audit. 

Does NY State audit tax returns?

Yes, the NY DTF can audit any returns that have been submitted to the agency. The state cannot audit federal returns, but it can audit any state returns including personal and business returns. 

How Long Can New York State Audit Tax Returns?

Based on the state's statute of limitations for auditing returns, the state can go back three years when deciding which returns to audit. The NY DTF can go back further if the taxpayer provides written consent. The three-year statute of limitations does not apply if the taxpayer failed to file a return, didn't report federal changes to their return, or filed a false return to evade tax. 

What are the reasons why an audit for New York State tax would be closed?

The auditor closes the audit at the conclusion of the audit. This happens after the auditor has reviewed all of the submissions and decided whether or not to make changes to the tax return. 

Get Help With New York State Tax Audits

New York State tax audits can be confusing and intimidating. The stakes can be high, particularly if the audit triggers a criminal investigation. To get through an audit as painlessly as possible, you should contact a tax professional for help, and if you're using possible criminal charges, you should always get a tax attorney to guide you.

A tax pro experienced with the New York Department of Tax and Finance can help you deal with a tax audit as easily as possible. They can guide you through both state and IRS audits. They can protect your rights during the audit and help to reduce your stress and tax liability as much as possible. They can be critical when you're arguing your position, especially if it hinges on a certain interpretation of the tax law. To get help now, contact a NY tax pro today.