Tax Audit Compliance and Documentation Strategy

Tax audits in New York generally fall into two categories, with the nature of the examination often dictated by the reason for selection.

Routine audits are standard administrative checks, while special audits may be unannounced and focus on specific issues such as unreported income or suspected fraud. Businesses with a history of irregular filings, unusually large deductions, or complex interstate income patterns may be more frequently selected for this intensive scrutiny by the New York DTF.

Before and during the audit, businesses must analyze the scope, organize documentation, and control communication channels.

• Reviewing the audit notice: Examine which tax years and tax types are under review to narrow the focus of your preparation.
• Identifying potential risks: Analyze previous returns for omissions, inconsistencies, or aggressive deductions that might attract auditor scrutiny.
• Organizing financial records: Ensure books, receipts, payroll, and vendor records are up-to-date, reconciled, and easily accessible.
• Designating a point of contact: Limit communication to a trained representative, such as a tax attorney or CPA, to maintain consistency and professional guidance.
• Responding clearly to information requests: Provide documents promptly, with supporting explanations, and avoid over-disclosure of unrelated information.

In New York, failure to keep proper records may result in estimated assessments under N.Y. Tax Law $685, making meticulous documentation critical. Auditors in the state may also use indirect methods like bank deposit analysis or markup testing to estimate unreported income, so businesses should be ready to address these findings with clear, substantiated records.

After the audit, a formal Notice of Determination will be issued detailing the auditor's findings and any proposed liabilities. Businesses then have a strategic decision to either accept the findings or address the determination.

• Accept and pay the assessed liability, often the simplest resolution for minor discrepancies.
• Challenge the determination by filing a protest with the Bureau of Conciliation and Mediation Services (BCMS) or requesting a formal hearing before the Division of Tax Appeals.

New York Tax Law allows 90 days from the date of the notice to file a formal protest, during which time the business should present legal and factual arguments supported by compelling evidence. Negotiation options, such as settlement conferences and payment installment agreements, may also be pursued at this stage to manage the financial impact of the assessment.

New York State auditors frequently request a wide range of documents to verify tax positions, so systematic organization is paramount.

• General ledgers and journal entries: Core financial records that map all transactions.
• Sales invoices and bank statements: Proof of income and cash flow movements.
• Payroll reports and W-2s: Verification of employment and wage withholding.
• Contracts with vendors and clients: Substantiation for major expenses and revenue streams.
• Expense logs and travel receipts: Detailed proof for deductions subject to strict IRS and NYS rules.
• Tax returns and amended filings: A complete history of all tax reporting.

Records must be retained for at least three years, as per most statutory limits, though retaining them for longer is highly recommended if prior audits are pending or complex tax positions are involved. To streamline the audit, businesses should digitize paper records, group files by tax year and category, and use secure, restricted-access cloud-based folders. These practices demonstrate professionalism and good faith, which can be helpful factors during an auditor's review and potentially reduce overall audit stress.

Under N.Y. Tax Law $685, various penalties may apply, including 5% for negligence, 10-20% for a substantial understatement of tax, and up to 75% for civil fraud. Criminal prosecution for intentional evasion may also be pursued under Tax Law $1802. Businesses facing these severe issues should immediately seek qualified legal counsel to manage communications and preserve their rights.

To formally challenge an audit result, the process involves a structured multi-level appeal system:

• File a protest within 90 days to the Bureau of Conciliation and Mediation Services (BCMS).
• If unresolved at BCMS, request a formal hearing at the Division of Tax Appeals.
• Submit comprehensive documentary evidence, witness testimony, and legal arguments at the hearing.

Should the initial appeal be unsuccessful, businesses retain the option to escalate the matter to the New York State Tax Tribunal or further seek judicial review in the Appellate Division of the New York Supreme Court. This layered appeals process provides multiple avenues for a taxpayer to present their case and address the validity of the state's assessment.