Personal Tax Audit: Procedures and Response Strategies

Inheritance, substantial gifts, and estate transfers often draw scrutiny from the DTF, particularly when required documentation like Form ET-706 (Estate Tax Return) is improperly filed or omitted. If the reported value of inherited property or taxable gifts is significant and not properly documented with legal instruments, an audit is highly likely. Inconsistencies between federal and state estate filings can also prompt a detailed review of the taxpayer's overall financial situation.

Sales or transfers of property in New York, especially those involving underreported capital gains or suspicious valuations, are a common personal tax audit trigger. The DTF compares property transfer reports and closing documents with individual income tax filings to detect inconsistencies or undisclosed income sources. Similarly, individuals with 1099 income, sole proprietorships, or income without standard employer withholding face increased risk. Misreported business deductions, inadequate expense substantiation, or failure to remit estimated taxes can result in an audit, particularly in high-cash industries.

The DTF begins the process by sending a formal “Notice of Audit Commencement” (Form AU-346) specifying the tax years under review and the areas of concern. Taxpayers are typically given a tight deadline, often 30 days, to formally respond and submit preliminary documentation supporting their original filings. Auditors request a broad range of records including bank statements, W-2s, 1099s, invoices, receipts, and any pertinent real estate or estate documents.

Understanding one's legal rights during a New York tax audit is paramount, as state tax law provides important procedural protections. Taxpayers may, and often should, retain legal counsel or a certified tax professional to represent them throughout the entire process, minimizing direct communication with the auditor. Residents are legally required to maintain adequate, well-organized records to support their tax filings for at least three years, and failure to cooperate or produce records can lead to adverse default assessments.

Before submitting any documents to the DTF, it is essential to meticulously review all past tax filings for the years under review. Ensure that all reported amounts precisely match supporting source documents such as pay stubs, 1099s, and K-1s. For real estate transactions, all supporting documents, including appraisal reports and HUD-1 settlement statements, must be readily available and cross-referenced with reported gains or losses. This internal review allows you to proactively address any simple errors or inconsistencies.

If an internal pre-audit review reveals material errors or unreported income, the New York Voluntary Disclosure and Compliance Program may offer a path to correction. This program can potentially allow a taxpayer to come forward and correct past non-compliance without facing substantial civil or criminal penalties, though it must be initiated before receiving a formal audit notice. Legal professionals are invaluable; they can assist in gathering and presenting evidence, managing all communications with the auditors, and negotiating a reduced assessment or penalties through administrative appeal.

At the conclusion of their review, the auditor issues a statement of proposed audit changes, detailing any adjustments to income, deductions, and tax liability. If the audit finds underreporting, the DTF will impose additional tax, accrued interest, and possibly civil penalties for non-compliance. Taxpayers have a critical right to formally contest these preliminary findings, first through an informal conference and then through administrative appeal channels, before the DTF issues a formal Notice of Determination and final assessment.

Certain reporting patterns significantly increase the probability of a personal tax audit in New York. Avoiding these practices and ensuring thorough documentation can drastically reduce risk.