How's your audit going, Prof. O'Keeffe?

Students have been asking me the question above.

Answer: slowly.

Timeline:

Friday Jan 29, 2010:
My husband and I receive two identical audit notices from NYS Tax Department Audit Division in the mail. Out of the blue, they have suddenly decided to challenge the fact that we had the audacity to claim both of our dependent daughters on our 2006 NYS tax return. (They were both full-time students, ages 16 and 20, and we provided 95% of their support, easily meeting the criteria to claim them as our dependents for both federal and state tax purposes. Before asking us any questions, the state peremptorily decided that we should only have claimed one. The burden of proof is on us to prove we are entitled to claim both daughters. We have birth certificates, tuition bills, and transcripts to establish dependent student status.)

The audit notices suggest we can deal with this by phone or mail.

Unlike the popular perception of an audit, the NYS Tax Department has no interest whatsoever in seeing us in person, so there's no option for a face-to-face encounter. Like most audits these days, this is a so-called "correspondence audit."

Monday February 1, 2010:
The issue should be very straightforward, so I spend 25 minutes on the phone, most of it on hold, with NYS Tax Department employees to explain the situation. No luck. The first person I reach tells me he can't resolve the issue, but transfers me to someone else he says will be able to help me. The second telephone representative says the matter is easy to resolve but ultimately tells me she can't actually resolve it herself. She tells me that I need to mail the information I've just given her on the phone.

Tuesday February 2, 2010:
I mail the requested information to the specified address, certified mail with delivery tracking.

Thursday February 4, 2010:
US Post Office notifies me electronically that they have delivered our letter to the NYS Tax Department.



Long pause....during which we hear absolutely nothing....



Thursday March 25, 2010: (SEVEN weeks after our letter was delivered to the NYS Tax Department.)
My husband and I get two identical copies of a letter from the NYS Tax Department stating that they have received the letter the PO delivered to them seven weeks ago.

That's pretty much all the letter states. They have received our letter. They have assigned us a "protest ID number." They will not take any further collection or enforcement action until "the protest has been resolved."

No word on how long we can expect until the audit is resolved. This is a very simple and straightforward issue. More gory details for those interested are in past posts here.

Running tally of easily measurable audit costs incurred by NYS tax authority:

Postage costs: $1.688 spent by NYS in metered postage for four envelopes containing a total of 14 pages of standard letter-sized paper, all of it computer-generated. $3.24 spent by me for postage to send required information certified mail with delivery confirmation.

Telephone costs: 25 minutes of connect time on their toll-free phone line attempting to resolve the audit on February 1. Most of this time was spent on hold, but live state employees spent about six minutes of time talking with me. I called from a landline, so no toll costs to me, but a low-income taxpayer whose only phone is a cellphone with costly pay-as-you-go minutes would have run up charges.

The amount of tax at stake for us is $68 plus $16 in interest the state proposes to assess. It is probably going to cost more than that in everyone's time and trouble to resolve, but it is educational for me! The amounts at stake for our low-income clients are much larger when their dependents are challenged.

Update: about one week later, we got another set of duplicate letters. The audit was resolved in our favor.

Further update:  The following year, we were audited again (on the same issue!)  However, it was much easier to respond.  The NYS Tax Department website is awesome.  It allows you to respond to an audit notice by uploading a PDF of your receipts and other supporting documents.  The IRS should take note and follow suit.

Update on my audit

It's been over five weeks since I sent exactly what I was told to send to respond to the NYS Tax Audit challenging our right to claim our 20-year-old college student daughter on our 2006 tax return.

Here's the tracking information from the Post Office, showing it was delivered on February 4.

Service Type: First-Class Certified Mail

Shipment Activity Location Date & Time
----------------------------------------------------------------------------
Delivered BINGHAMTON NY 13902 02/04/10 12:33pm

Arrival at Unit BINGHAMTON NY 13902 02/04/10 8:48am

Acceptance SCHENECTADY NY 12309 02/02/10 10:12am

The ball has been in their court for five weeks.

No word yet.

To see the complete saga of posts on my audit thus far, click here.

Update on the audit

I went to the Post Office yesterday to mail off the documentation requested by NYS Tax Department "Audit Group 3" telephone representative.

Basically, she said that I all I needed to do was to explain that we'd declined to claim our older daughter on the federal form in order to allow her to get the education credit and to provide the name and Social Security number of our daughter, so the tax department could look up her tax return and see that she hadn't claimed her own exemption on her return. (Why the NY tax form didn't give any opportunity to provide this information right on the original tax return in the first place is not clear. The federal Form 1040 requires listing the names and SSNs of all dependents claimed on the return, but the NY tax return did not and still does not provide any place to do that.)

It's also unclear to me why the Audit Group 3 phone representative could not just take that minimal information directly over the phone from me, especially since the wording of the audit notice letter had suggested it was possible for taxpayers to resolve matters over the phone, and this matter does look extremely straightforward.

(It's possible that their idea of "resolving matters over the phone" means getting the taxpayer to agree that the NYS Tax and Finance Department is correct and pay the assessed amount by credit card over the phone! Perhaps the only people who need to respond by mail are those who don't agree with the bill enclosed with the audit notice. It's likely that they hope many taxpayers will take the path of least resistance and just surrender and concede the bill, even if it's not correct. The National Taxpayer Advocate's reports have pointed out that many low income taxpayers--who are far more likely to be audited than the average American--do exactly that.)

But...whatever....off I trotted to the Post Office to mail off the form with an attached letter of explanation providing the information required. I sent it Certified Mail ($3.24) and set up email notification, so I'll know when it arrived. There's a good chance it will arrive today (2/3/2010), which is somewhat strange to contemplate, since the audit notice letter itself was dated 2/4/2010.

More reflections on phone information

Although I'm not a big fan of phone calls, I did want to call to make sure I was sending exactly the right documents that would be required to resolve our correspondence audit. And I also wanted to get some insights into how much difficulty a low-income taxpayer might have in navigating the phone interface of the NYS Tax Department.

Upon further investigation and reflection after my experiences this morning, the phone information provided in the audit letter was definitely NOT as helpful as it could have been.

1) Page 7 of our audit letter stated that "If you prefer to resolve your disagreement by phone, call the toll free Personal Income Tax Customer Service Center number given on the enclosed Notice of Taxpayer Rights."

However, the only actual toll free number given on the "enclosed Notice of Taxpayer Rights" is 1-800-462-8100. A taxpayer who attempts to follow the advice given on page 7 will only waste more costly cell phone minutes (toll free doesn't mean free if you're calling from the kind of cell phone plan most of our low income clients have!) only to learn he's reached the number for ordering forms, certainly not the number for resolving an audit disagreement by phone.

2) There is also a NON toll free number given on the above-referenced page: 518-485-6800, but since the toll free version originally pointed out explicitly as the place to call to resolve problems hadn't worked, I assumed that the corresponding toll version wouldn't work either. (I later called the number and it appears that in fact the toll version WOULD have worked! So if only page 7 had pointed the taxpayer to the toll version initially, he might have reached someone who could help him.)

3) Anyway, instead I called the number given on page 8 of the tax audit notice enclosure, the one labelled "If you have questions regarding this notice, call 518-457-5434. That was a number that should have been answered starting at 8 a.m., according to the NY Tax Department website, but as I indicated earlier, when I called at 8:20 a.m., the recording just informed me that the office was closed and I should call back during "normal hours," without actually telling me what those hours were!

These may all seem like minor petty details, but the cost of calling several incorrect numbers or at several incorrect times adds up for the millions of New York taxpayers who have to deal with complying with our tax code.

In our case the audit issue was clear and straightforward, but for a taxpayer with a more complicated issue, and perhaps with only a limited number of minutes left on his phone plan and no money to buy more, these kinds of issues DO add additional stress!

And, the fact is that if our tax code (both federal and state) were simpler, taxpayers would not need to be wasting nearly as much of their time AND of government employee time AND running up phone bills on both ends dealing with all these bed buffaloes in our tax code.

It's not the fault of the NYS Tax Department that the tax code is so complicated, but the audit letter could at least avoid wasting taxpayer time and cell phone minutes by clearly directing taxpayers to the correct phone number to call and the correct time to call those phone numbers. Those misdirected phone calls that come in at the wrong time or to the wrong number run up the state's phone bill as well.

Phone log with the NYS tax department dealing with the audit

According to the NYS Tax website, taxpayers can call them weekdays between 8 a.m. and 5 p.m.

Here's my phone log.

8:20 a.m. Monday Feb 1

I called the phone number listed in my audit notice, which is the main number for billing, payments, and information, 518-457-5434.

I immediately connected to a voice menu, listened to the options, punched in 1 for "Personal income taxes," and then was invited to punch in my Social Security number, which I did. As soon as I punched in my SSN, a recorded voice message repeated my SSN back and asked me to press 1 to confirm it, which I did.

It then played the following message:

"The office is currently closed. Please call back during normal hours."

The message did not give any information as to what the supposedly "normal hours" are. The website says 8 to 5 on weekdays. It's 8:20 on a Monday.

Anyway, if I was calling outside the supposedly normal hours, why didn't the voice menu tell me that before inviting me to punch in information. If I'd been a low-income taxpayer worried about using up cell phone minutes, I would not be very pleased about this.

I'll keep trying.

8:32 a.m Called again. Went through the punching SSN, reading back and confirmation steps. This time I was quickly transferred to a very nice representative who gave his name as Steve, if I recall correctly. I explained that I wanted to explain the circumstances to disagree with the audit notice I had received. He asked again for my SSN, along with my name, address, home phone, and employer's names. I believe the reason for asking all this information was to confirm my identity before disclosing any sensitive information.

After I provided satisfactory answers to those inquiries, Steve politely but firmly stated that we owed New York State $84.08 and that we should pay that amount before February 25 to avoid additional interest and penalties.

When I reiterated that we wanted to explain the information we needed to provide to disagree with the bill, he said he would need to transfer my call to another department ("Audit Group 3") in order to get the information about the documents required to do that. He also helpfully gave me the direct number for Audit Group 3 in case I got disconnected and once again very politely but firmly advised that we should pay the bill by February 25 to avoid additional interest and penalty.

(This information repeatedly provided by Steve is very important for many taxpayers, who may be uncertain about whether their position is correct. If I were less than 100% confident that the position we took on our return was correct, I would consider following his advice to pay the amount in question before February 25 to stop the clock on the interest and penalties. If I later turned out to be correct, I could still file to get a refund of that amount, possibly with some interest. If I turned out to be incorrect, however, following Steve's admonition would have saved me interest, which is currently running at 7.5%, as well as possible penalties.)

8:38 a.m After Steve transferred me to the line for Audit Group 3, a recorded voice asked me to punch in my SSN yet another time, followed by a request to punch in my zip code. The recorded voice then informed me that all lines were busy, but predicted a wait time of approximately 7 minutes. So I waited on hold, listening to reasonably soothing if somewhat repetitive music, periodically interrupted by messages telling me that my call was important to them and encouraging me to consult the website for additional information.

8:54 a.m. After 14 minutes on hold, I reached a very helpful and efficient telephone rep who did not give her name. She again requested my SSN and my name and then told me we owed $84.08 on our 2006 New York taxes.

When I explained that we disagreed with the bill and explained our reasons, she listened and provided clear information about what we would need to do. We simply need to attach a letter to the audit notice disagreement form providing our daughter's name and SSN and stating that we had been entitled to claim her on our 2006 federal tax return but had chosen not to do so in order to allow her to get the education credit on her federal return. Once they get that information, they will be able to look up the information they have on our daughter's federal and state returns and confirm that our information is consistent with those returns.

I had hoped that perhaps she could just take the information about our daughter's name and SSN over the phone, but apparently not. I guess that it's understandable that they want to keep telephone calls short, to avoid making hold times even longer for other taxpayers, so I will go off to the Post Office later today and mail the letter via certified mail.

Although she did not tell me to do so, I will take special care to use the return envelope provided in the audit notice, since I understand that the window in the envelope will allow a barcode to show through to the outside that will expedite processing once it reaches the NYS Tax and Finance Department.

End of phone call: 8:56.

Total elapsed time for the phone call: 24 minutes, including 14 minutes on hold, four minutes talking to Steve, two minutes talking to the Audit Group 3 employee, and four minutes dealing with listening to voice menus and punching in numbers.

Plus an additional minute or so wasted on the 8:20 attempted phone call, where I was invited to punch in my SSN and confirm it before being told the office was closed and to call back during the unspecified "normal hours," and waiting another 10 minutes to call back after making the apparently correct guess that maybe 8:30 was the beginning of "normal hours."

It was a local call for me and we have unlimited local calling from our landline, so no phone charges for us. However, many low-income taxpayers have calling plans which might make those minutes a costly expense.

Still, all in all, it was not nearly as bad as I expected, especially since I imagine Monday morning right after W-2s come out must be a peak calling time for the tax department.

Bed buffaloes in our tax audit

Here are the bed buffaloes that led to our audit:



Bed buffalo #1: New York State tax law does not allow the same number of deductions for exemptions as federal tax law.

While taxpayers are allowed to claim deductions for both personal exemptions and dependent exemptions on their federal tax return, the State of New York now only permits taxpayers to claim deductions for dependent exemptions. (Apparently, there was some distant time in the past, prior to 1988, when New Yorkers could claim personal exemptions for themselves as well as dependent exemptions for their dependents, just as they do on their federal returns, but no more. I can't for the life of me understand why the NYS Legislature decided to create trouble and confusion for taxpayers by deciding to change the definition of allowed exemptions back in 1988 so that it no longer aligned with the federal definition, but I guess we are stuck with that bed buffalo. Changing it back to conform with the federal definition would likely only cause more confusion at a time when state tax administration resources are already stretched thin! And our state legislature is even more notoriously dysfunctional now than in the past. In any case, we only moved to New York in 1989, and so our family has always known we could only claim our dependents as exemptions on our NYS returns.)

The NYS Tax Department folk are very aware that this is confusing for some folks, and every year they highlight this distinction, both on the tax form and in the accompanying instructions.

This is understandably confusing for many New York taxpayers and errors are quite common, especially for taxpayers who do their returns by hand. It's quite understandable that many taxpayers might reason: "I claimed four exemptions on my federal return and so I get to claim four exemptions on my state return," even though the New York instructions say otherwise. (This is not too surprising--life is short and the tax instruction manuals are long, and only tax policy wonks like me actually think they make interesting reading! Actually, I don't find the instructions especially interesting reading, but I do feel compelled to read them, since I want to keep my family AND our VITA taxpayers out of tax trouble!)

Bottom line: So the maximum number of exemptions we were eligible to claim on our 2006 federal return was four (two personal exemptions for my husband and myself and two dependent exemptions for our daughters.) The maximum number of exemptions we could claim on our 2006 state return was only two (just for our two daughters--none were allowed for ourselves.

We did not exceed those limits. So why does New York think we made a mistake in claiming our two daughters on our New York return?

Read on more for more bed buffaloes.



Bed Buffalo #2: Federal tax law provides that parents may decline to claim a dependent child on their federal tax return in order to allow that child to claim education credits on their own federal return.

We had done exactly that. Our income was too high to claim the education credits on our federal return, so by declining to claim our older daughter on our federal return, we enabled her to claim the education credit on her federal return. We did lose the value of her dependency exemption on our return, but due to dependent exemption phaseout provisions in the tax code (another bed buffalo in the tax code I won't go into here), that exemption wasn't actually worth all that much money to us.

Discussing this strategy gives me an opportunity to comment on a tangentially related bed buffalo that can gore the unwary.



Bed Buffalo #3: Declining to claim dependents that you could have claimed on your return does NOT, under current tax law, allow those dependents to claim their own personal exemptions on their returns!

A taxpayer who CAN be claimed by another taxpayer as a dependent may NOT claim a personal exemption for herself, even if that taxpayer entitled to claim her declines to claim her.

I knew that, of course, so I made sure to keep my daughter from being gored by that particular bed buffalo, but many people do not realize this.

Okay, enough on that side note, our family successfully dodged that bed buffalo. Back to the consequences for our New York return.

Yet another bed buffalo!



Bed Buffalo #4: Even though we had chosen not to claim our daughter on our federal return, New York State still allowed us to claim her on our NYS tax return.

I remember discovering this particular bed buffalo back in 2006, finding it somewhat surprising at the time. I had initially assumed that choosing not to claim her on our federal return would preclude claiming her on our state return, but page 94 of the 2006 NY Income Tax Instructions reads:

If you were entitled to claim a dependent on your federal return but chose not to in order to allow your dependent to claim the federal education credit on his or her federal tax return, you may still claim him or her as a dependent on your New York return.

(Conveniently those 2006 instructions are still available available online. In fact for the obsessively curious or very delinquent late filers, instructions are still available on-line going all the way back to 1985!)

So, I followed the instructions and did exactly what the worksheet on page 94 told us we could do: claim dependency deductions for both daughters on our New York return even though we had only claimed one of them on our federal return.

As far as I can tell, we followed the tax instructions correctly to the letter, but we still got ensnared in an audit triggered precisely by the discrepancy between the one dependent claimed on our federal return and the two dependents claimed on our New York return.

Why? Because the New York State tax forms did not--and still do not--provide any place where the taxpayers can explain why the number of dependents they claim on their state return exceeds the number of dependents that they claimed on their federal return.

Since New York State tax authorities are understandably diving into the sofa cushions for much needed tax revenues, they recently obtained a datatape from the IRS allowing them to compare the total number of exemptions claimed on 2006 federal returns (in our case that number was 3, my husband, myself, and our younger daughter) with the total number of exemptions claimed on 2006 NYS returns (in our case that number was 2, just our two daughters.)

Most of the people swept up in that comparison net were people who had been gored by Bed Buffalo #1 above, people who wrongly claimed personal exemptions themselves and/or their spouses on their NY returns, due to confusion with the federal rules.

Some of the people who successfully navigated Bed Buffaloes #1, #2, and #4, may find that when they mail in their required explanation, that the tax authorities will realize their dependent child was actually gored by Bed Buffalo #3, which could result in additional money owed by the dependent child, on her federal and/or state returns, if s/he wrongly claimed a personal exemption for herself.

I believe our family has successfully navigated around all the Bed Buffaloes listed above, but I need to call the NYS tax department folks to find out exactly what documents we should provide to prove this to their satisfaction.

Stay tuned for more.

What does a tax audit look like?

The image that comes to most people's minds when they picture a tax audit is a taxpayer sitting across a desk from a government auditor.

Once upon a time, that was true, but nowadays the overwhelming majority of what the IRS and New York State authorities call "audits" of individual taxpayers are "correspondence" audits conducted through the mail.

This is true for taxpayers at all income levels. It's just a practical reality--the tax agencies are under pressure to do more and more with less and less, and correspondence audits enable scarce auditor resources to be stretched a lot farther.

There are still a few face-to-face audits. Apparently, Taxgirl Kelly Erb had a face-to-face audit, presumably in an office, and I recently read an email on the TaxProf list from a law school professor who was expecting a tax auditor to come to her home to conduct the audit there. The professor said the worst part was having to clean up her home for the auditor! (I can definitely relate to that!) Perhaps coincidentally, both Kelly and the law school professor used to work for the IRS. Kelly has noted that she herself had previously been on the other side of the table from the taxpayer.

But most audits are not face to face, so perhaps you'd like to take a look at what a correspondence audit looks like. Here is a PDF of the initial letter for our NYS correspondence audit, with sensitive personal data (like Social Security numbers and our total taxable income) deleted.

I must say that I was initially rather taken aback at the strong boldface heading of at outset of the letter: NOTICE AND DEMAND for Payment of Tax Due, given that this was the first thing we'd heard from the state about our 2006 return since we'd filed it almost three years ago.

It seemed that the New York State Tax Department was coming on awfully strong in its very first ever approach to inquiring about our tax return. (It's my impression that the first notice in a correspondence audit from the IRS is not worded quite so strongly, but then I've yet to see one, so I don't know for sure.)

But after reading a lot of Treasury Department and GAO reports on correspondence audits, I realize that a lot of taxpayers just ignore tax audit correspondence, so maybe the New York tax officials have a good case to make that they need to be somewhat alarmist to make sure they grab the taxpayer's attention quickly.

That boldface headline certainly got my attention! I will be taking care of this matter pronto!

Later on in the letter, there is a page with the comforting title of "Taxpayer Bill of Rights," but it's full of scary things that could happen if we don't pay up or at least respond with our version of the facts within 30 days. (Seizing assets, filing liens, garnishing wages--none of it very reassuring, and certainly none of it does any good for one's credit rating, reputation with the bank or one's employer.)

The audit letter also has another page that provides the possibly comforting information that if one spouse wants to blame it all on the other spouse, s/he has the right to try to prove to the satisfaction of the tax authorities that s/he knew nothing about the allegedly incorrect information provided on the tax return and that s/he did not benefit from the allegedly ill-gotten tax gains from the allegedly incorrect information provided by his/her spouse.

None of this was any comfort to me. As the spouse who is supposed to be the expert at dealing with taxes in our house, any error would be almost surely be attributable to me. (My daughters sometimes irreverently refer to me as the "tax goddess.")

So I read everything over very carefully--and then breathed a deep sigh of relief--I think!

When I got around to reading the smaller and somewhat fuzzier computer print on the back of the first page, it yielded the information that suggests we may not have too much difficulty setting things straight--I hope.

If you're not familiar with New York tax law, I need to explain a few bed buffaloes in the code to help clarify this matter.

UPDATE: An earlier version of this post was getting way too long. I have decided to break it up into pieces. A separate post explaining those bed buffaloes in our tax audit will be up soon.

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.