Why would a state tax bureau audit you?

Well, one of the easiest ways to get your … in a sling is to file federal taxes and omit sending in your state taxes. But, I assume you and your tax preparer (because WE would NEVER do that) are smart enough to realize that is a profoundly dumb idea.

Another way to find yourself undergoing a state audit- the Feds corrected your tax return. Like that $ 10,000 lottery ticket winnings you failed to declare. And, you didn’t correct your state tax return. Whoops. Guess you didn’t realize that the Feds and the States have a deal- any changes to a tax return is reported to the other.

But, let’s get to the more typical reasons. (I have to assume you have some integrity- and some intelligence. After all, you ARE reading this blog, right?)

States are desperate for revenue. So, the easiest way they can collect is to (a) search for sales tax revenue they didn’t collect [which is not the subject of this post] or (b) to seek out revenue that was earned in the state (from pass-through or from residents claiming residency in another state) and which seemed to have missed their collection plate.

There is one key factor to recognize about tax audits. Not just state tax audits- but federal ones, too. We are not in a court of law (sometimes, it doesn’t feel that there are any laws)… which means “guilty until proven innocent” is a concept that holds no water. The burden of proof is on the taxpayer and/or the tax advisor.

Here are some great ways to trigger a state tax audit.

•  Claim your residency in Florida or Texas, or other low/no income tax states.
  It’s not just California and New York that are examining claims of residency in Puerto Rico, Wyoming, Arizona, Texas or Florida. Even my domicile, the Commonwealth of Virginia, is policing such claims.
  Let’s pick an example. (No, I am not going to mention its name.) A client claimed they now reside in Florida. Since we do taxes for folks across the globe, the state’s claim that they didn’t change tax advisors held no water. (I do admit, that was a good try!)
  But, the client did buy a new car- in the state that was investigating his claim of non-residency. And, when the state asked for his credit card records, this client’s goose was cooked. About 80% of the purchases were in the state the client claimed to have departed.
  So, yes. If you claim you’ve moved to another state, make sure you have proof that you are present in that state more than one you left- or you will find yourself owing back taxes, penalties and interest.

Most states use multiple factors to discern a taxpayers domicile.

They compare residences between your old and new state (size,                 value, nature)                                                                                                                       Where the taxpayer’s employment/business connections                             reside                                                                                                                                     Where keepsakes are maintained (old or new residence)                             Family ties to the new and old domicile                                                                  And, of course, did the taxpayer spend 183 days in either state.                     (Parts of days count as whole day. You can be a resident of two states!)

• Multiple abodes.
  This was one of my problems. Way back in the 1980’s, I had residences in both Virginia and California. (I spent about 3 days in each, about 24 hours or so in the air.) The tipping point was summer vacation, when my kids could be with me for three or four weeks- I didn’t have to commute then. My residency was in California. (Yes. I know that cost me way more money. But, I was also ensuring [to no avail whatsoever] that my children could attend college in California for next to nothing.)
  But, this problem is more typical for retirees, snowbirds, and professional athletes. Moving from a high to low tax state will almost guarantee an audit. But, winning one audit won’t guarantee permanent success. Cash-desperate states will continually examine residency/non-residency issues repeatedly.
  One must continually monitor how many days they can be considered in a state. 182 days has to be the max! And, we suggest that this be digitized records, so permanent records will be available for an audit.
• Sale of a Business or another “Big” Asset
  No, it’s not really the sale of a business or the asset that triggers this audit. It’s when the folks looking to sell their business abandon the state where that business operated forever- right before the sale is constituted. Or try to move somewhere where the capital gains taxes on the sale of the assets will be attenuated.
  The issue is if the state can show the owner kept working in the business or remained in the state, even after the owner claimed to have relocated to a new domicile. Travel records will have to be produced to demonstrate that the domicile really changed.
• Children Going to School in Another State
  Many parents have sought ways to minimize the tuition their children pay for college. So, they invent new ways to afford the child to claim residency in the state where the college resides.
  The first thing to recognize is that this action- if it works at all- will require at least 12 months. The child will need to be working in the new state. And, a summer job is not going to be enough. There needs to be proof that the student is really living in the new state- so employment should be for several months- or even a few weeks for each of the seasons of the year.
  But, one of the key things forgotten in this scenario is that the child needs to obtain a driver’s license from the domicile they claim. (Often, this is a primary issue- since the parents also own the car the child uses and the insurance is under the parents’ name(s).)
  What often happens when the plan is not well formulated is that the child owes taxes to both jurisdictions- and fails to be considered a state resident for tuition purposes.

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