If your tax client is being audited by the IRS, their state’s Department of Revenue, or both, they’ll likely have questions for you about the differences between state and federal audits and what they should expect.
To help your clients feel prepared for the process, here’s how you can answer some of their top five most frequently asked questions.
What’s the difference between a state and a federal tax audit?
The main difference between a state audit and a federal audit is who performs them. Federal audits focus on federal tax returns and are performed by the IRS. State audits focus on state tax returns and are performed by a state’s Department of Revenue. Even though state and federal tax returns are typically prepared at the same time, it’s possible to have issues with one and not the other.
Will a federal audit trigger a state audit or vice versa?
Sometimes, but not always. Because the IRS and the individual states’ Departments of Revenue investigate two completely separate tax returns, it’s possible to be selected for a state audit and not a federal audit (or vice versa). If a state audit is simply the result of typos or simple mistakes on your client’s state tax return, it’s possible that their federal return did not have any of the same issues.
However, larger mistakes or intentional falsehoods in filing are more likely to trigger an audit. For example, if a client falsely claimed a dependent or failed to report all of their income, these issues likely exist on both returns, and the IRS and state organizations will often notify each other in these instances. In these cases, it’s very probable that the individual will be audited by both their state and the IRS.
Why was my client selected for a state and/or federal tax audit?
Some of the factors that make a tax return more likely to be flagged for an audit are the same for both federal and state returns. For example, these issues might raise red flags in the IRS as well as a state’s Department of Revenue:
- Very high income
- Taking an unusual amount of deductions relative to others in the same income bracket
- Unreported Income
- Multiple parents/ caregivers claiming the same dependent
Some factors increase a person’s likelihood of facing a state audit but not a federal audit. Taxpayers are more likely to face a state audit if they:
- Work in a different state than the one they live in
- Own a business that operates in multiple states (Nexus)
Who can represent my client in a state or federal tax audit?
In a federal audit, you can represent your client if you have the proper credentials. The following people can represent individuals before the IRS:
- Enrolled Agents
- Non-credentialed tax preparers who have completed the IRS’s Annual Filing Season Participant Program but only if that person also prepared the tax return
Most states have similar guidelines for representation in a state tax audit, although they may not grant representation rights to non-credentialed tax preparers. Each state will have different laws for audit representation, so be sure to check that state’s guidelines.
Do state and/or federal audits result in criminal charges?
Many people automatically associate “audit” with “criminal investigation,” but this just isn’t always the case. Both states and the IRS can prosecute for criminal tax fraud and evasion, but audits are much more frequently resolved without any criminal charges. Of course, if your client knowingly committed tax fraud, criminal charges are a possibility, and they may need the services of a tax attorney.
What you can do as a preparer
If you have representation rights before the IRS and your state’s Department of Revenue, your clients may want you to represent them during the audit. You can help them gather necessary documents, dispute the findings of the audit, and settle on a payment plan if it is found that they owe money.
Even if you can’t formally represent your client, you can help them know what to expect during a state or IRS audit. You can also point them to resources for help and representation such as Audit Maintenance Pro or Protection Plus’s audit assistance professionals.
The information in this article is up to date through tax year 2021 (returns filed in 2022).