Tax audits are official examinations of a taxpayer’s financial records to ensure tax returns are accurate and comply with applicable laws. Both state tax audits and IRS audits aim to verify proper reporting and payment of taxes but differ significantly in scope, process, and enforcement.
What Is a Tax Audit?
A tax audit is a detailed review conducted by tax authorities to confirm that income, deductions, credits, and tax payments were reported correctly. Audits can result from random selections, computer-generated flags for anomalies, or specific tips and complaints.
How State Tax Audits Work
Each state administers its own tax rules, rates, and filing requirements through its Department of Revenue or Taxation. A state tax audit typically:
- Is conducted by state tax agents focused on state tax filings such as income tax, sales tax, business taxes, or property tax.
- Reviews compliance with state tax laws, focusing on income earned within the state, allowable deductions, and credits.
- May be conducted by mail, phone, or in person.
- Targets taxpayers based on risk profiling, random selection, or specific leads.
- Imposes state-specific penalties, interest, and back taxes if discrepancies are found.
For more details on state audits, see our State Tax Audits guide.
How IRS Audits Work
The IRS oversees federal taxes including federal income tax, payroll taxes, estate and gift taxes. IRS audits:
- Are carried out by IRS agents following federal tax code and regulations.
- May review specific items or the entire federal return.
- Begin with a mailed notification letter requesting documentation.
- Can involve correspondence audits, in-office audits, or field audits conducted at a taxpayer’s home or business.
- Carry potentially significant penalties, and in cases of fraud, can lead to criminal charges.
Learn more about IRS audits in our IRS Audit glossary entry.
Key Differences Between State Tax Audits and IRS Audits
| Aspect | State Tax Audit | IRS Audit |
|---|---|---|
| Jurisdiction | State tax authority | Federal government (IRS) |
| Types of Taxes | State income, sales, business, property tax | Federal income, payroll, estate, gift taxes |
| Focus Areas | State tax laws, local deductions, credits | Federal tax code, income, payroll taxes |
| Notification | Usually by mail | Typically by mail; sometimes phone contact |
| Audit Methods | Mail, phone, in-person | Correspondence, office, or field audit |
| Penalties & Interest | Vary by state, can be substantial | Can be more severe; includes criminal penalties |
| Coordination | May coincide with IRS audit but separate | Separate audit process |
Real-World Examples
A California small business might undergo a state audit by the Franchise Tax Board (FTB) for state income and sales tax, while simultaneously facing an IRS audit for federal income and payroll taxes. Similarly, a New York freelancer could be audited separately by the NY State Department of Taxation and Finance and the IRS for their respective filings.
Who Can Be Audited?
Any taxpayer filing federal or state tax returns can be audited. Audits are triggered by risk factors such as:
- Errors or omissions
- Unusually large deductions or credits
- Income discrepancies compared to third-party reports
- Prior audit history
- Random computer selection
Maintaining organized tax records can greatly ease the audit process. Visit Record Keeping for Taxes for guidance.
Tips for Handling Both Audits
- Keep detailed documentation of all income, expenses, and deductions.
- Respond promptly and courteously to audit notices.
- Understand the specific requirements of each audit.
- Consider consulting tax professionals experienced in audits.
- Explore payment plans or penalty relief programs if applicable.
Common Misconceptions
- IRS audits always lead to state audits: Not necessarily; audits are independent.
- State audits are less serious: State penalties can still be costly.
- In-person appearance is always required: Many audits are manageable by mail.
- Paying immediately is best: Review audit findings or seek professional advice before paying.
Frequently Asked Questions
Q: Can the IRS share audit information with state tax agencies?
A: Occasionally, but each audit is generally handled separately.
Q: Which audit is more common?
A: IRS audits are more frequent federal actions, but some states conduct numerous state-level audits.
Q: What triggers audits?
A: Automated data matching, discrepancies, and referrals often trigger audits.
Resources
- IRS Audit Process: irs.gov/audits
- State Tax Audits Overview: consumerfinance.gov
- California Franchise Tax Board: ftb.ca.gov
- New York State Tax Department: tax.ny.gov
Understanding these distinctions helps taxpayers navigate audits with confidence. Staying organized and informed is key to responding effectively to both state and federal tax examinations.