New York Tax Audit Compliance and Documentation Strategy

Tax audits in New York generally fall into two categories:

Routine audits often come with a 15-day advance notice. Special audits, however, may be unannounced and focus on specific issues such as unreported income or suspected fraud. Businesses with a history of irregular filings, large deductions, or unusual income patterns are more likely to be selected.

Before the audit begins, businesses must analyze the scope and duration of the audit. Key steps include:

• Reviewing the audit notice: Examine which tax years and tax types are under review.
• Identifying potential risks: Analyze previous returns for omissions, inconsistencies, or aggressive deductions.
• Organizing financial records: Ensure books, receipts, payroll, and vendor records are up-to-date and reconciled.

In New York, failure to keep proper records may result in estimated assessments under N.Y. Tax Law § 685. Therefore, documenting every transaction with proper substantiation is critical.

During the audit, auditors may request interviews, site visits, or further documentation. Key practices include:

• Designating a point of contact: Limit communication to a trained representative such as a tax attorney or CPA.
• Responding clearly to information requests: Provide documents promptly, with supporting explanations.
• Protecting confidential information: Share only what is asked. Over-disclosure can expose unrelated liabilities.

Auditors in New York may also use indirect methods such as bank deposit analysis or markup testing to estimate unreported income. Businesses must be ready to rebut these findings with clear records.

After the audit, a formal Notice of Determination will be issued. Businesses then have two options:

1. Accept and pay the assessed liability, or
2. 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 notice to file a protest. If the business disputes the findings, it must present legal and factual arguments, supported by evidence. Settlement conferences and payment installment agreements may also be negotiated at this stage.

New York State auditors frequently request the following:

• General ledgers and journal entries
• Sales invoices and bank statements
• Payroll reports and W-2s
• Contracts with vendors and clients
• Expense logs and travel receipts
• Tax returns and amended filings

Records must be retained for at least three years, though longer is recommended if prior audits are pending or complex tax positions are taken.

To streamline the audit:

• Digitize paper records and store them securely.
• Group files by tax year and category (e.g., payroll, deductions).
• Use cloud-based folders with restricted access to sensitive materials.
• Keep audit response logs documenting all communications with auditors.

These practices not only reduce stress during the audit but demonstrate professionalism and good faith—factors that can influence auditor discretion.

Under N.Y. Tax Law § 685, penalties may apply for:

• Negligence or disregard of rules (5% of underpayment)
• Substantial understatement of tax (10-20%)
• Fraud (civil penalty of 75%)

Criminal prosecution may be pursued under Tax Law § 1802 for intentional fraud or evasion. In such cases, businesses must seek immediate legal counsel and avoid self-incrimination during communications.

To challenge an audit result:

• File a protest within 90 days to BCMS.
• If unresolved, request a hearing at the Division of Tax Appeals.
• Submit documentary evidence, witness testimony, and legal arguments.

If the appeal fails, businesses can escalate the matter to the New York State Tax Tribunal or further to judicial review in the Appellate Division of the New York Supreme Court.