Overview

State departments of revenue select returns for audit to close tax gaps and ensure compliance. Audit types commonly mirror federal practice: correspondence (document requests by mail), office/desk audits (review at a state office), and field audits (in‑person examinations). Selection may come from automated data‑matching, tips, third‑party reporting (W‑2/1099), or cross‑matching against federal returns and other states.

Common triggers (real examples)

  • Mismatched income: Third‑party reports (1099s, W‑2s) that don’t match your state return. Many states use data matching similar to the IRS (see IRS audits overview: https://www.irs.gov/audits).
  • Large or unusual deductions: Home‑office, travel, or meal deductions that are large relative to income.
  • Net operating losses, large business losses, or repeated losses for a business that claim no reasonable profit expectation.
  • Residency and allocation issues: Conflicting state addresses, travel patterns, or employer filings that suggest a different taxable state.
  • Related party transactions and activity across state lines: Multistate activity often draws scrutiny (see our guide on Navigating Multistate Tax Audits: Preparing Records and Responses).
  • Random selection or tips from third parties.

How audits are often discovered

You’ll receive a formal notice from the state tax agency—never by phone claiming immediate payment is required. Notices typically arrive by mail and outline what years and items are under review. If you get a call, verify by asking the agent to send written notice and confirm their contact info with your state’s department of revenue website.

Immediate steps after receiving a notice

  1. Read the notice carefully. Note deadlines and the scope of the audit. Don’t ignore it.
  2. Don’t volunteer extra information beyond what’s requested. Answer directly and in writing where possible.
  3. Gather documentation tied to the items under review (see checklist below).
  4. Consider engaging a CPA or tax attorney—representation can prevent missteps and streamline communication.
  5. Request clarification in writing if the notice is unclear. Keep records of all correspondence.

Documentation checklist (assemble promptly)

  • Federal and state tax returns for the years under review.
  • Third‑party income reports (W‑2s, 1099‑MISC/NEC, 1099‑K).
  • Bank statements, merchant records, and ledgers that support deposit and expense amounts.
  • Receipts and invoices for business and deductible expenses (meals, travel, supplies).
  • Contracts, canceled checks, and proof of residency or business location.
  • Payroll records if wages or contractor status are questioned.

Practical response tips (from practice)

In my work advising clients, early organization and a focused audit package turn audits from confrontations into process checks. Provide a concise document index and only the documents requested—organized chronologically or by line‑item. If you don’t have a document, explain why and provide alternative substantiation (bank activity, contemporaneous notes).

When to hire help

  • You’re unfamiliar with the tax issues raised.
  • The proposed adjustment is large or includes penalties and interest.
  • The audit involves multiple states or nexus/residency determinations.

A qualified CPA or tax attorney can negotiate with auditors, raise legitimate defenses, and file appeals if needed. For multistate matters, specialized advisors familiar with state nexus and apportionment rules are especially valuable.

Appeals, penalties, and timelines

Each state sets its own statutes of limitations, penalty rules, and appeal process. Commonly, states allow an administrative appeal followed by a state tax court appeal. Do not miss appeal deadlines; they are strict. Check your state department of revenue site for procedures and timelines, and for general federal audit guidance see the IRS audits page (https://www.irs.gov/audits).

How to reduce future audit risk

  • Keep thorough, contemporaneous records for at least the years still subject to assessment.
  • Reconcile returns with third‑party reporting before filing.
  • Use conservative, well‑documented positions for deductions and credits.

Resources and internal guides

Authoritative sources

  • IRS — Audits and Appeals: https://www.irs.gov/audits
  • Your state Department of Revenue website (procedures and contact points vary by state).
  • Multistate and state guidance for nexus and allocation issues (state DORs and the Multistate Tax Commission).

Disclaimer

This article is educational and not personalized tax advice. Rules and deadlines vary by state and can change; consult a CPA or tax attorney for advice tailored to your situation.