How the Potential IRS Audit Push Could Affect Your State Income Tax Returns

Written by: Kristen Schroeder—Director, State Income Practice Lead

The Internal Revenue Service (IRS) is ramping up its tax enforcement efforts thanks to a massive funding and new legal powers. The IRS is targeting large corporations and high-income individuals who are suspected of evading or underreporting their taxes. It is also focusing on certain areas of tax compliance, such as foreign activity, transfer pricing, and research and development credits. These areas are complex and require extensive documentation and support.

Large companies face a higher risk of being audited by the IRS, and they need to be prepared for the potential consequences. An IRS audit can result in adjustments to income, expenses, deductions, and credits, which can affect federal and state income tax liability. An IRS audit can also trigger amended returns, which can lead to additional penalties and interest. Moreover, an IRS audit can be time-consuming, costly, and disruptive to the business operations and reputation.

In this article, we explain how the IRS audit wave affects your state income tax returns,  common issues and challenges you may face, how to avoid audits, what to do if you are audited, and how DMA can help you with your state income tax needs.

How the IRS Audit Push Affects State Income Tax Returns

The IRS audit wave significantly impacts your state income tax returns because most states base their tax calculations on the federal taxable income. Therefore, any changes or adjustments to your federal income tax return as a result of an IRS audit may also affect your state income tax return. Depending on the state tax laws and the timing of the audit, you may have to file amended returns, pay additional taxes, or claim refunds for your state income taxes.

Common issues and challenges seen with state income tax returns due to an IRS audit include:

• State Conformity: Not all states conform to the federal tax laws and definitions, and some states may have different rules and rates for certain items of income, expense, deduction, or credit. For example, some states may not allow the same amount or type of depreciation or may have different limitations or exclusions for certain deductions or credits. Therefore, you need to be aware of the state-specific tax rules and adjustments that may apply to your state income tax return, and how they may differ from the federal tax rules and adjustments.
• State Attribute Tracking: If your company has undergone an IRS audit, you may need to adjust your state attribute tracking accordingly. State attribute tracking is the process of keeping track of the differences between the federal and state tax attributes, such as net operating losses, tax credits, or basis. Depending on how your state conforms to the federal tax rules and definitions, IRS audit adjustments may have different implications for your state income tax returns. Some states may automatically adopt the federal changes, while others may require separate reporting or adjustments. You should review your state attribute tracking for each state in which you have nexus and update your state income tax returns to reflect the impact of the IRS audit adjustments.
• State Credits and Incentives: You may be eligible for certain state tax credits or incentives, such as research and development, job creation, or investment. These credits or incentives may have specific requirements and limitations and may be subject to recapture or clawback if you fail to meet the conditions or expectations. Monitoring and documenting your compliance with the state credit or incentive agreements is the key to success, and how the IRS audit adjustments may impact them.
• State Statutes of Limitations: You may have to file amended returns for your state income taxes within a certain period after the IRS audit adjustments are final. Each state has its own statute of limitations for filing amended returns, and some states may have different rules for refunds or assessments. It’s crucial to be aware of the state filing deadlines and procedures, and how they may vary depending on the nature and direction of the IRS audit adjustments.

How to Avoid Audits and What to Do if Your Company is Audited

The best way to avoid audits is to file accurate and complete tax returns, and to keep good records and documentation of your income, expenses, deductions, and credits. Consulting with a qualified tax professional can help you with your tax planning and compliance. By working with your team, a tax professional can also advise you on the latest tax laws and regulations.

Do not panic or ignore the IRS notice if you are selected for an audit. Respond promptly and professionally, cooperate with the IRS requests for information and documents, and then seek assistance from a tax professional who can represent you and protect your rights and interests during the audit process. A tax professional can help you prepare for the audit, communicate with IRS agents, negotiate audit results, and appeal the audit findings if necessary.

Additionally, consider the impact of the IRS audit on your state income tax returns and take the necessary steps to comply with the state tax laws and requirements. Work with a tax professional who can help you with your state tax issues and challenges and assist you with your state tax filings and audits.

How DMA Can Help

At DMA, we have a team of experienced and knowledgeable tax professionals who can help you with your state income and franchise tax needs. Whether you need help with your current year state tax compliance, amended returns,  state tax credits and incentives, or state tax audits—we can provide you with the best solutions and strategies for your situation.

We can help with:

• State income taxes and RAR amended returns: If you are subject to an IRS audit, you may also have to file amended returns for your state income taxes, depending on the outcome of the audit and the state tax laws. We can help you determine your state tax obligations and prepare and file your amended returns promptly and efficiently. We can also help you with any state tax audits or controversies arising from your amended returns.
• State credits and incentives: Our team helps identify and claim your eligible state tax credits or incentives and monitor and document your compliance with the state credit or incentive agreements. We assist with any state audits or inquiries regarding your credits or incentives and advise you on the best practices and strategies to maximize your credit or incentive benefit and minimize your audit risk.

Team Up With DMA

The increase in potential IRS s may significantly impact your state income tax returns—and your tax team needs to be prepared. DMA has the expertise, experience, and resources to help you prepare for an IRS audit push. Contact us today to learn more.