State Audits Just as Bad as U.S. Residency Rules Can Lead to Tax BlundersBy Vivian Marino Times-Picayune February 27, 2000 As if the Internal Revenue Service were not enough for them, manytaxpayers are at risk of being audited by state tax authorities, and in many instances the experience can be equally unpleasant. Consider Martha Stewart, the purveyor of gracious living and founder of a media empire bearing her name. She has had a less-than- genteel experience with New York State auditors involving a country home in East Hampton. The state contended that she owed taxes as a resident because she spent most of her time there during a certain period; she said she was not a New York resident. She lost on appeal, however, in January. "It's very common," said Larry Elkin, an accountant from Hastings- on- Hudson, who has represented clients who have been audited by New York, one of the more aggressive states in tracking down tax revenue. "Arduous is probably the best word to describe the process." The level of questioning from the auditors -- no matter the state -- can be far more intrusive than even the IRS auditing process, Elkin and other tax professionals say. Audited taxpayers must often produce bundles of documents and paperwork to prove their cases. The issue is generally whether a person is a resident and thus subject to more extensive state taxes. What many people do not realize is that a person can legally be classified as a resident of more than one state. A common test for residency is that a person have a permanent place of abode and spend more than 183 days of the year there, said John Logan, a senior tax analyst at CCH Inc., a tax consulting firm in Riverwoods, Ill. Spending even part of a day in New York would count, he said. Thus a resident of Connecticut or New Jersey who has a job in New York and an apartment for occasional use might well be classified as a New York resident. Even a trip to La Guardia Airport to catch a plane might count as a New York day. There are ways to avoid a state's tax traps, however. Logan noted, for example, that Vernon Jordan, a friend and adviser of President Clinton, is reportedly commuting to his new job at Lazard Freres & Co. in New York from Washington and living out of a suitcase in a Park Avenue hotel room, which would not be considered a permanent abode. Jordan did not return a phone call to his office asking for comment. Many audited taxpayers, including some who have homes in more than one state or who have moved from one state to another, have felt they are living in a paperwork nightmare, trying to come up with past years' receipts, many of them the seemingly trivial sort that most people discard, to prove they were in a state other than the one claiming them as residents. "If you went to the hardware store or if you brought your cat to the vet, you will want to produce receipts of that to show that you lived where you lived," said Edward Slott, an accountant from Rockville Centre. "You may have to sit down with a calendar and recollect everything you did." Elkin said he finds the process "unusually intrusive" for clients. "Whoever might have thought," he asked, "that they would have to explain to a tax examiner who they made a long-distance call to and why they made that call?" In Stewart's situation, she and the tax professionals at Arthur Andersen, which represented her, had to dredge up reams of personal and business diaries, credit card receipts, limousine driver records and telephone invoices from the early 1990s, the period in question. Despite their efforts to prove that she spent less than 183 days at the East Hampton house, she lost on appeal Jan. 13 before Thomas Sacca, an administrative law judge at the Division of Tax Appeals in Troy. Arthur Andersen partner Alan Luchs said neither the company nor his client, who calls Westport, Conn., her home, would comment on the case. Of course, not everyone who is audited will be forced to keep daily itineraries or be subject to intense interviews. As with most IRS audits, the majority of state encounters are likely to be through the mail, often to clear up minor discrepancies -- perhaps an entry on a tax return does not jibe with a Form 1099. In New York, only 5,729 of the 488,159 individual audits conducted last year were "field audits," involving direct contact between auditors and taxpayers or their representatives, said Marc Carey, a spokesman for the New York State Department of Taxation and Finance. The total audits represented about 6 percent of the 8.5 million income tax returns. "The vast majority of taxpayers are paying their taxes promptly and in full, and the audit process is very simply a necessary way to preserve that integrity of the system" and catch cheaters, Carey said. "Auditing is never going to be a pleasant process," he said. Even tax professionals say they understand why some states are aggressive. "It is much too easy for a New Yorker, say, who has a vacation home in Florida to claim Florida residency and thus shirk his New York tax obligation," Elkin said. Florida is one of six states without an income tax. There is some relief, however, for retirees who move to warmer, tax-friendlier climates. A 1996 federal law bars states from taxing retirement income of any individual who is not a resident of that state. New York previously taxed pensions that it contended were earned in New York, even if the retiree moved to another state. Still, tax professionals complain that many honest people -- often those who move out of a state where they remain employed -- have become automatic targets of audits, mainly because they earn high incomes. "The further up the food chain you go, the more likely you will run into a very aggressive state audit," Elkin said. "They are going where the money is. They see a big number on a tax return and say,'Gee, maybe there's a chance some of it is ours.' " |
