Are State Tax Audits Going to Increase? | USTaxAid

Diane Kennedy's Blog

Are State Tax Audits Going to Increase?

Written by Diane Kennedy, CPA on December 5, 2008

It’s no secret that states are hurting for money, and are looking for ways to raise needed revenue however possible. I’ve been seeing some signs that taxpayers may face an increasing audit risk at the state level, as local governments do whatever it takes to keep the state operating.

The news is pretty much the same across the country – the tax base is shrinking. When people lose their homes there’s no property tax to collect, and when they lose their jobs, income and sales tax revenue falls as well. But the states still have people to employ and programs to fund. Some states have asked the federal government for loans or bailouts of their own to cope. But they’ll be looking for other ways to raise money, too.

A couple of days ago I came across an item in a tax ticker talking about states that have opted out of depreciation deductions enacted at the federal level. For example, 23 states now have laws on the books partially or fully denying the 50% bonus depreciation put into place by the federal government for the 2008 and 2009 tax years. So while you’ll get the deduction at the federal level, you’ll be adding the deduction back in before calculating your state taxes.

Increasing state audits may also be on the table. Consider this item, reported by the California Franchise Tax Board concerning personal audits related to the mortgage interest deduction:

Audits of tax returns with large home mortgage interest deductions indicate that many taxpayers and tax practitioners are not complying with the rules regarding the debt limitations home mortgage interest deductions. To fully deduct the home mortgage interest, the interest must be paid on acquisition or equity debt. The aggregate amount treated as acquisition debt for any period must not exceed $1 million (or $500,000 in the case of a married individual filing a separate return). The maximum aggregate amount of home equity debt for any period is $100,000 (or $50,000 in the case of a married individual filing a separate return). Thus, the aggregate amount of the principal balance of all the mortgage loans used in computing the home mortgage interest deduction may not exceed $1.1 million (or $550,000 in the case of a married individual filing a separate return). The acquisition debt or the home equity debt must be secured by the principal residence of the taxpayer, or one other residence of the taxpayer used as a residence and selected by the taxpayer for the taxable year. New debt that a taxpayer incurs to refinance acquisition indebtedness also qualifies, but only up to the amount of the refinanced debt. Taxpayers must figure the average balance of each mortgage to determine their qualified loan limit. They can use the highest mortgage balance during the year, but they may benefit most by using average balances.

Businesses won’t escape either. My guess is we’ll likely face an increase risk for sales and use tax audits. Use tax is the one state auditors look for in particular, especially if you live in a state that borders a state with no sales tax (i.e., Oregon), or if you buy a lot of things online. Popping over a state line for supplies, office equipment, computers, etc., to save on the sales tax is a long-standing custom for personal and business consumers. And there are billions of dollars being spent online, again, with no sales tax being collected. But, what many fail to recognize is that there is no free ride. When you buy something outside of your local state, you are required to declare the value of that purchase, calculate what you would have paid if you’d bought it in-state, and send that money, called a Use Tax, to your local state government instead. Use tax is an easy and lucrative target for state auditors, so be warned!

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