Both the state and federal taxing authorities audit tax returns that are filed to report income and expenses. Let’s face it, neither a federal audit nor a state audit is any fun at all for the taxpayer. Reasonable expenses can be disallowed if adequate proof is not provided by the taxpayer and additional tax as well as penalties and interest can be assessed. If the taxpayer uses a tax professional to assist in compiling and presenting documentation to the taxing authorities, there are additional professional expenses. If the taxpayer does not use professional assistance, they may step in on a legal landmine because they don’t understand important details of the state or federal tax code. This sounds like a no-win situation. Unfortunately, it really is.
A federal audit is potentially worse than a state tax audit for a taxpayer because the common perception is that the federal government will criminally prosecute a taxpayer for mistakes on the tax return. In actuality, there are both state and federal criminal laws that would apply to tax returns if there is fraud or there are intentional misstatements of income or expense involved. Mistakes are not criminally penalized in most cases. There really is such a thing as an “honest mistake”.
Regardless of the honesty of a mistake on our tax return, there are civil financial penalties that can be substantial for errors on a tax return if they are in the taxpayer’s favor and result is less tax due on the return. If the error or mistake is made in the government’s favor, the taxpayer may actually be entitled to a refund. While it is relatively rare, an examination of the taxpayer’s return can result in a refund, including interest for the money that would have been due had the return been filed correctly.
In our experience, state tax audits can be both grueling and disproportionately expensive for a taxpayer. Because state tax rates are lower than federal rates, the amounts of money are often smaller than audits associated with a federal tax return. However, that does not mean the state auditor will not dig in mercilessly to recover every single penny that is due to the state treasury. In fact, state auditors are often less flexible than a federal auditor.
Even if you are audited by only one of the taxing authorities, information on the results of your examination are frequently shared with other jurisdictions. For example, the federal government and state governments have agreements to share the results of their audits with each other. Some states, such as Oregon, have a statute that requires you to report the initiation of an audit examination and the results of that audit when it has concluded. That can result in a “double whammy” with both state and federal tax liability the result of an audit by only one of the two jurisdictions.
Let’s hope that you are not selected for examination by either the state or the federal government. However, if you are selected for examination, we recommend that you contact your tax return preparer, a CPA, or our office for assistance and advice early in the process. We may be able to head off a more detailed examination involving multiple years and additional areas of your tax return not initially selected