Managing State Tax Audits (Portfolio 1730)

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Tax Management Portfolio, Managing State Tax Audits, No. 1730-2nd, focuses on the state tax audit process and provides practical insights in planning for and managing state tax audits.

This portfolio addresses state tax audits primarily in the context of income and sales and use tax audits. The authors describe the state audit process and provide planning opportunities that can minimize the time, expense, and exposure of a state tax audit. While addressing procedures to follow during a field audit, the ideas discussed herein also apply in responding to questions during a desk audit. It also takes a look at some emerging, nontraditional audit techniques.

The portfolio discusses in detail the audit selection process, how an auditor prepares for an audit, and the types of preparations a taxpayer should make before an auditor walks in the door. It sets out the ground rules all parties should follow before, during, and after an audit. The portfolio also discusses the various audit techniques used and how the different audit techniques may impact a taxpayer's net liability. In addition, the portfolio discusses computer–assisted audit methods and how the growing reliance on computer systems is changing how audits are performed. It provides key points on managing an audit, bringing an audit to closure, and how to proceed in the case of disputed audit results.

This portfolio may be cited as Amato, Yanover, and Simonetti, 1730-2nd T.M., Managing State Tax Audits . Within the Multistate Tax Portfolio Series, however, references to the portfolios will include only the portfolio numbers and titles.


John Amato

John Amato is State Tax Counsel with General Electric Company in Stamford, Connecticut where he is responsible for state income and franchise tax audits, appeals, and litigation for the GE financial services group of companies. John has spoken for various organizations such as the Tax Executives Institute (TEI), Council on State Taxation (COST), Interstate Tax Corporation, Paul J. Hartman SALT Forum, and the Equipment Lessors and Finance Association. He has co-authored various articles on state taxation which have appeared in such journals as the Journal of State Taxation, the Journal of California Taxation, and Interstate Tax Insights.

Frank A. Yanover

Frank Yanover was formerly GE Capital's Sales and Personal Property Tax Director and Senior Tax Counsel in Chicago, Illinois. Prior to that Frank managed General Electric's Income and Franchise Tax Audit and Litigation Group. He has over 25 years of state and local tax experience and has managed state and local tax matters in well over 75 jurisdictions. Prior to GE, Frank worked at RJR Nabisco, Horwood Marcus and Berk and did time at Touche, Ross & Co. He received his J.D. degree from American University's Washington College of Law and his B.S. degree in accounting from Fairleigh Dickinson University and is a member of the Illinois Bar.

Frank is on the COST Board, the editorial staff of the Interstate Tax Report, the Journal of State Taxation and is on BNA's Advisory Board and Deloitte's Advisory Board for their annual National Multistate Tax Symposium. He was co-chair of the NY Business Council's Tax Committee, has published many articles and has lectured before numerous groups including various TEI chapters, COST, the NYS Bar Association, The National Multistate Tax Symposium and the Hartman Institute. Finally, Frank is on the NY and Illinois’ Department of Taxation Taxpayer Advisory Boards.

Marc A. Simonetti, Esq.

Marc A. Simonetti is a Partner with Sutherland Asbill & Brennan LLP in New York, New York, who concentrates his practice on state and local tax matters. Marc practices in all areas of multi-state tax including litigation, planning and legislative analysis. He leads Sutherland's effort to advise clients on the financial statement impact of uncertain state tax positions, including the requirements of Statement of Financial Account ASC 740- (formerly known as Financial Accounting Standards Board's Financial Interpretation Number 48) and ASC 740 - Financial Accounting Standard 5.

Table of Contents

Detailed Analysis


Introductory Material

A. Scope of Portfolio

B. Local Audits


Introductory Material

A. Audit Selection

B. Preparations by the Auditor

1. Review of Previous Audit Files

2. Review of Returns Under Audit

3. Review of Public Information

4. Preparation of Audit Plan

C. Preparations by the Taxpayer

1. Examine Prior Audit Files

2. Examine Current Tax Related Files

3. Preparation of Audit Plan

4. Education of Company Employees

5. Compile Basic Information

6. Audit Periods

7. Use of Industry Network

D. Establishing Ground Rules

1. Entrance Conference

a. Initial concerns of the taxpayer

b. Initial concerns of the auditor

2. Taxpayer's Agenda

3. Maintenance of a Daily Log

4. Contract Auditors

5. Use of Pre–Entry Agreement with Contract Auditors

6. Confidentiality

7. Strategy on Handling Refunds, Credits, and Other Overpayments

a. In General

b. Don't Count on the Tax Auditor for Help

c. Semper Pro–Active!

E. Other Pre–Audit Planning Issues

1. Keep Your Objective in Mind

2. Fact Advocacy

3. Anticipate the Tax Collector

4. Document Preservation

5. Using a Checklist

6. Planning is a Team Effort

7. Never Forget to Use Good Judgment

F. Audit Techniques

1. Sampling

2. Other Methods

a. Mark–Up

b. Observation Tests

c. External Indices

G. Computer–Assisted Audits

H. E–Commerce Audits


Introductory Material

A. Reaching an Agreement Before the Audit Begins

B. Determining the Scope of the Exposure if a Waiver is Not Signed

C. Ensuring That the Waiver Also Applies to Refunds

D. Restricted Waivers

E. Conditional Waivers

F. Signing the Waiver

G. Additional Waivers


A. In General

B. Building a Relationship Conducive to a “Good” Audit

1. Provide a Comfortable, but Controlled Work Environment

2. Be Punctual

3. Be Reserved, but Respectful

4. Be Prepared

5. Be Involved


A. Preliminary Issues

1. Locating the Auditor

2. The Introductory Meeting

3. Brief Explanation of the Company's Business

4. Controlling the Auditor's Access to Information

5. Employee Interviews

6. Document Request Form

7. Photocopies

8. Scheduling

9. Free Lunch

10. Handling a Difficult Auditor

B. Information Requests

1. In General

2. Requirement to Maintain and Provide Records

3. Third Party Records

4. Other Information Requests

a. Other State Returns

b. 50–State Apportionment Spreadsheets

c. Customer Lists


A. In General


A. The Auditor's Preliminary Workpapers

B. The Taxpayer's Response

C. Meeting With Audit Supervisor

D. Negotiating

1. Capacity of State's Representative to Deal

2. Forcing the State to Defend its Position

3. Going “Up the Line” in the Agency


A. Preparation of the Written Protest

B. Preparing for Oral Protest Hearing

C. Alternative Dispute Resolution


Introductory Material

A. Factors to Consider Before Hiring an Advisor

B. Whom to Employ and How

C. Advantages and Disadvantages of Hiring an Advisor


A. Expense


A. Communication of Audit Results to Management

B. Updating of NOL and Credit Carryover Schedules

C. Dealing with the State Tax Accounting/Book Effect

D. Other Considerations


Introductory Material

A. Definitions

1. Certified Audit

2. Computer–Assisted Audit

3. Contract Audit

4. Effective Rate Agreements

5. Field Audit

6. Managed Audit

7. Reverse Audit

8. Self Audit

9. Voluntary Disclosure

B. Managed Audits

1. Overview

2. Ohio's Managed Audit Program

3. Other States' Managed Audit Programs

a. California

b. South Carolina

c. Virginia

d. West Virginia

e. Connecticut

f. Texas

g. New Mexico

h. Arizona

4. Other Applications

5. Penalties and Interest

C. Certified Audit Programs

1. Florida

2. Illinois

D. Effective Rate Agreements

1. Background

2. How Effective Rate Agreements Work

3. Potential Drawbacks

4. Overpayments and Underpayments

E. Contingent Fee Arrangements

1. Overview

2. Lonky v. Municipal Tax Bureau Inc.


Working Papers

Working Papers

Item Description Sheet

Worksheet 1 California Taxpayers' Bill of Rights

Worksheet 2 Texas Audit Procedures

Worksheet 3 Rev. Proc. 98–25, 1998–11 I.R.B. 7 (3/16/98)

Worksheet 4 MTC ADR FORM 100 (November 1995)

Worksheet 5 Ohio Managed Audit Guidelines

Worksheet 6 California State Board of Equalization Application for Voluntary Disclosure

Worksheet 7 Minnesota Department of Revenue Business Activity Questionnaire

Worksheet 8 New Mexico - Managed Audits For Taxpayers

Worksheet 9 Excerpt from our 2008 Survey - State Voluntary Disclosure Audit Programs