Another tax blogger gets audited

First Taxgirl Kelly Erb, now me.

Two letters arrived at our house yesterday, each with an ominous return address:

New York State Department of Taxation and Finance
Audit Division-Income/Franchise Desk AG3
W A Harriman State Campus
Albany NY 12227-0001

Upon opening both envelopes up, I discovered two identical letters (even the document number was the same on each, as was the AUDIT ID number), each of them six pieces of paper long. I don't know why the NYS Tax Department chose to send us two copies of this letter in two separate envelopes, each of which bore 48.2 cents in metered postage. At least two of the pages were printed on both sides, so we are talking 8 pages of printed text in each envelope.

The boldface header that first caught my eye was intimidating:

NOTICE AND DEMAND for Payment of Tax Due

A quick glance showed that the audit concerned our 2006 New York State tax return, which we filed in April 2007, almost three years ago. This is the first we had heard about any issues on our 2006 return, so the title of the notice was a bit alarming.

Ancient history, I thought, wracking my memory to try to remember what possible tax issues could come up from that year. I knew we should have all the archived receipts from that year stored in our basement file cabinet, but I wasn't exactly looking forward to spending the weekend digging through them. (It's a very busy time at our VITA site, as you might imagine, since most people get their W-2's this week.)

As I read through the letter, I figured out exactly what the New York tax authorities were challenging on our 2006 return: it was not any sort of exotic tax shelter (not that we have any of those!)--it was the dependency deduction we had claimed for one of our two daughters!

We had claimed two dependents on our 2006 New York return, resulting in a tax savings of $68 per child in NYS taxes that year, but the New York audit division has apparently decided we were only entitled to claim one daughter and is demanding $68 in back taxes plus $16.08 in interest on the back taxes allegedly due for the unspecified daughter they assert we were not eligible to claim on our NY return.

(Interestingly, they are not attempting to assesss any penalty, since the penalty amount is listed as $0. Apparently they are trying to be understanding about the penalty since the rules for claiming dependents are so complex.)

Hmmm, but $16.08 in interest on a $68 tax liability allegedly overdue for almost three years, that's an APR of about 8%, a pretty good investment return for the state these days. Where else can you you get those kinds of interest rates on your investments these days?

So the state of New York is demanding $84.08 from us, unless we can justify the two dependents we claimed on our 2006 New York return to their satisfaction. The burden of proof is on us.

Our daughters were 16 and 20 in 2006. Our 20-year-old was a fulltime college student in 2006, and we have transcripts and tuition receipts to prove it. Neither daughter provided more than 50% of her own support. Both were US citizens. Both daughters lived with us, at least in the way that the tax authorities define "live with," since our older daughter was actually away at college most of the year. I remain completely confident that both of them met all the criteria to be our "Qualifying Children" dependents that year.

The notice didn't specify which daughter's exemption they were challenging, so I suppose we will have to respond to the audit by documenting that both of them met the criteria to be claimed as our dependents.

It is might very well cost more than $84 in time and trouble to straighten this out, but hopefully the process will be enlightening and educational for others.

I'll keep you posted on how this works out. I'll also post a PDF of the letter (with personal details redacted) which explains why the NYS Audit Division suddenly decided to challenge our claiming our two daughters on our tax return--apparently out of the blue--almost three years after we filed our return.