Individual Income Tax - Taxpayer's Audit & Appeals Procedure
"Oh no I am being audited - now what?"
So…these are some of the most dreaded words you’ll ever mutter. Right? Well, that’s not always the case. The Department and the Taxation Division are committed to protecting your rights and making the audit experience as unobtrusive and cooperative as possible. In addition, with the Taxpayer Bill of Rights, your rights are also guaranteed by law.
The following is a scenario of what may occur during the audit process of an Arizona individual income tax return. While this is meant as a guideline to help you through this process, if there is any omission on this site or any inconsistency with the statutes or rules, the language of the Arizona Revised Statutes and the Arizona Administrative Code will prevail.
Through the Exchange of Information Agreement between the federal and state taxing authorities, and as part of its ongoing endeavor to treat each taxpayer fairly, the Department strives to issue the most accurate proposed assessments using all of the available information.
- The first step of an audit is to send you a letter requesting information, or clarification. An example of this would be when you are asked by the auditor to send documentation of expenses you claimed as a medical expense on your itemized deduction.
- Another situation would be if the Department is notified by the Internal Revenue Service that you filed a federal income tax return indicating a home address in Arizona and research of our records does not show a Arizona income tax return filed for the same tax year. In other words, you appear to be a non-filer: someone who was required by statute to file a return, but failed to do so. More about this later.
- Most letters request a response within 30 days from date of the letter. If more time is needed to gather documentation, be sure to call your auditor and ask for an extension. Under most circumstances, the auditor has authority to grant this request. But remember, if you do not respond, the next step will be the issuance of a notice of proposed assessment which has legal consequences and may be totally unnecessary. So PLEASE, do respond to the initial inquiry letter from the auditor.
- After you have responded, either a "no adjustment/thank you" letter or a proposed assessment is mailed to you. If you have a valid Power of Attorney (AZ Form 285) form on file, a copy of the notice will also be mailed to your representative.
- A "no adjust/thank you" letter is just that. Thank you for providing the necessary information, no adjustment is needed on your return and your file for this year (s) is closed.
- A "Notice of Proposed Assessment" shows additional tax due and a "Notice of Proposed Determination" shows a refund or a credit. (ARS § 42-1108) The Taxation Division is committed to determining the correct amount of tax and is equally satisfied with a refund determination as it is with an deficiency determination.
- On the other hand, if you do not respond or provide documentation as needed, you will receive a "Notice of Proposed Assessment" explaining the adjustments, the statutory authority for making these adjustments, applicable penalties, and statutory interest.
- You, as a taxpayer, have the right after receiving this notice to discuss the information contained therein, and the right to protest any part or all of the proposed assessment. You have ninety days to file this protest with the Audit Section or the proposed assessment becomes final. Therefore, if you disagree, don’t forget to complete the taxpayer response form and mail it to the Section. If you have misplaced the form, you can download it here: Assessment Protest Form.
- If you disagree with some or all of the proposed assessment or determination, you should communicate with the auditor. Perhaps you misunderstood something; perhaps the auditor did. Effective communication between you and the auditor is the key to an amicable resolution of the issues. If you are unable to communicate effectively, you can request the opportunity to discuss the findings in an informal conference with another auditor or a supervisor. Such a request is entirely appropriate and is part of the audit resolution process.
- If you convince the auditor or conferee that your assessment should be modified, you will receive a modified proposed assessment (if the result is no change from your return as filed, you will instead receive a letter indicating your audit is complete and no change is being made). A key word here is still proposed. A "Modified Proposed Assessment" is issued and shows a change(s) made to the original proposed assessment or determination. For example, if the auditor proposed to disallow $1,000 of medical expenses, and you demonstrated to the auditor’s satisfaction that $500 of those were appropriate, the auditor would modify the proposed assessment to reflect that change. Another example would be if a taxpayer showed that his failure to file his return timely (normally by April 15) was due to a medical emergency, proving reasonable cause. The Audit Section could agree to waive the applicable penalty, and issue a modified proposed assessment.
You have ninety (90) days to respond to the proposed assessment or determination:
- If you have protested the original proposed assessment, your protest remains in place and you need to indicate whether you agree or disagree with the modification. If you have not protested the original proposed assessment, and you are still within the ninety day protest period from the issuance of the original proposed assessment, you can still protest the remainder of the assessment.
- If you do not respond within the allowed time frame, you have not lost your right to protest. You may pay the taxes owed and then file a claim for refund. This claim for refund must be filed with six months of payment or four years from the due date of the original return or the date you actually filed the original return, whichever is later. If your claim for refund is denied, then you may go through the appeals process
- If you agree with the audit , the assessment may be paid in full any time. If no protest is filed, the audit will go on billing, and the collections system will send a bill based on the deficiency assessment. All bills which are the result of deficiency assessments are due and payable in full within 10 days from receipt of such bill.
- If you cannot pay the liability in full within 10 days, you have the right to request an installment plan with the Department’s Collection Section. A form for requesting such relief was in your audit packet; if you have misplaced it you can download a copy here.
Protesting the Proposed Assessment or Determination
- If you disagree with the proposed assessment, a written appeal (protest) must be submitted within 90 days stating the "reason why the redetermination should be granted and the amount on which any tax, interest and penalties should be reduced." For a Protest Packet click here.
Interest continues to accrue
- The Collections Section is notified of the protest, and billing of the entire liability is postponed until the appeals process is completed. However, interest continues to accrue. Simple interest accrues during the calendar year and is compounded annually on January 1. (ARS § 42-1123)
- On the Protest Packet form , you may choose between an informal conference and a formal hearing. Most protests are resolved during an informal conference. You may choose to resolve the dispute over the telephone, by written submission, or meeting with the auditor or a representative of the Audit Section. This is another opportunity to present any information or documentation that supports the protest and to discuss any questions regarding the audit.
Three things can happen here:
- the auditor abates the audit in full;
- the auditor modifies the original proposed audit; or
- the auditor disagrees with the documentation and issues the proposed assessment.
- If the assessment is modified , you will be asked to state if you agree with the modification(s) and withdraw the protest or disagree and request a formal hearing.
- If a satisfactory resolution is not achieved, you may request a formal hearing. The formal hearing, conducted by an impartial hearing officer from another division of the department, consists of you and/or your representative along with a representative from the Individual Income Tax Audit Section.
- Arizona Supreme Court’s Rule 31 limits who can represent a taxpayer before the department’s Hearing Officer. By order dated January 6, 2000, the Arizona Supreme Court has amended Rules 31(a)(4)(M) and (N ) of the Rules of the Supreme Court. The amendments to this rule, effective June 1, 2000, are as follows:
- M. In any administrative proceeding before the Arizona Department of Revenue or before the Office of Administrative Hearings relating to the Arizona Department of Revenue, a taxpayer may be represented by (1) a certified public accountant, (2) a federally authorized tax practitioner, as that term is defined in A.R.S. § 42-2069(D)(1), or (3) in matters in which the dispute, including tax, interest and penalties, is less than $5,000.00 (five thousand dollars), any duly appointed representative. A legal entity, including the Department, may be represented by a full-time officer, partner, member or manager of a limited liability company, or employee, provided that: the legal entity has specifically authorized such person to represent it in the particular matter; such representation is not the person’s primary duty to the legal entity, but secondary or incidental to other duties relating to the management or operation of the legal entity; and the person is not receiving separate or additional compensation (other than reimbursement for costs) for such representation.
- N. If the amount in any single dispute before the State Board of Tax Appeals is less than twenty-five thousand dollars, a taxpayer may be represented in that dispute before the board by a certified public accountant or by a federally authorized tax practitioner, as that term is defined in A.R.S. § 42-2069(D)(1).
The hearing office will give you a minimum of 20 days written notice of the time and place of the formal hearing. (ARS § 41-1061.A) Hearings are held at the department’s offices located in Central Phoenix (Downtown), East Phoenix Metro Area (Chandler), and Tucson, in person or by telephone. You may also request to have the hearing by written memoranda.
- At the formal hearing, you will have the opportunity to present your case, including any additional information, to the hearing officer. Upon review of all evidence, the hearing officer will issue a written decision, usually within ninety days. (ARS §42-2063) The decision is sent to you by certified mail and by regular mail to your representative (if any). A Blue sheet is attached to the decision which outlines your appeal rights, should you disagree with the decision.
What happens if I still don’t agree with the Hearing Officer’s Decision?
YOUR RIGHTS DON’T STOP HERE
If you disagree with the hearing officer’s decision , you may appeal in writing to the Director of the Arizona Department of Revenue, or you can bypass the Director and file an appeal with the Board of Tax Appeals (BOTA). Your appeal to either level must be filed within thirty (30) days of receipt of the Hearing Officer's decision. The decision is sent by certified mail to you and by regular mail to your representative (if any).
- The Director will issue a decision within 90 days after each side had submitted its position.
- If you disagree with the Director’s decision, you may then initiate an appeal to BOTA.
- You must file your written appeal within 30 days of receipt of the Director’s decision.
BOTA – What is it?
The Board of Tax Appeals consists of private citizens, appointed by the Governor, who are not connected with the Arizona Department of Revenue. The members of BOTA have diverse backgrounds and are charged with impartially resolving various taxpayer issues. Currently two members of BOTA are CPAs and one is an Attorney. As in the formal hearing, you have the opportunity to present your case to the Board. The Board will issue its decision. The Board of Tax Appeals is the final step available in the administrative appeals process.
If you disagree with the decision of the Board of Tax Appeals, you may enter the judicial system by filing a complaint in the Tax Court (Superior Court) within sixty (60) days of the BOTA decision.