Withholding Tax Audits
In order for the Arizona Department of Revenue (ADOR) to equitably administer Arizona tax laws, the Department will conduct audits to ensure taxpayers are in compliance.
This is especially true concerning withholding tax. In Arizona, it is the responsibility of the employer to withhold Arizona income tax from employees’ wages and to report and remit taxes withheld to ADOR.
When an employer withholds the tax imposed by Arizona law from an employee and submits it to ADOR, the state will hold that tax amount in a trust fund until the employee claims that withheld amount on his or her individual income tax return.
Rights and Confidentiality
The state of Arizona and the Arizona Department of Revenue are diligent in ensuring individuals and businesses are aware of and able to exercise their procedural rights. Taxpayers can review the following publications to learn more about these rights:
Yes, ADOR adheres to strict rules to ensure that no one views taxpayer information without proper authorization.
If representation by someone other than the taxpayer is necessary, taxpayers can add a power of attorney (POA) to their account. ADOR will not share information with anyone without the taxpayer’s expressed permission to do so through a POA. Taxpayers may use Form 285 to authorize ADOR to release confidential information to the taxpayer’s appointee. A taxpayer may also use Arizona Form 285 to grant additional powers to an appointee. Please note that Arizona Form 285 can only be executed by a principal corporate officer (corporations), partner (partnership), or an owner (sole proprietorship).
During an ADOR withholding tax audit, taxpayers can correspond with the Department through email and phone interviews, and they can usually provide documentation to the Department in electronic format.
A taxpayer will be sent an “Intent to Audit” letter that explains ADOR’s intention to examine payroll records and other documentation for a specific audit period. Along with the letter, the taxpayer will receive a questionnaire about his or her business, focusing on employment issues.
The taxpayer will also receive a “Records Requirement List,” which indicates the documentation the Department is requesting to begin its initial examination. The “Intent to Audit” letter explains expectations for return of a completed questionnaire and required documentation within 15 days from the day the taxpayer receives the letter; otherwise, an assessment will be created using the best available information.
An audit generally covers the most recent four-year period. However, if tax returns have not been filed, the statute of limitations may be longer. This will result in the audit period extending beyond four years, but not to exceed seven years.
During an audit, ADOR prefers taxpayers provide records via electronic means. This improves the accuracy of the audit, reduces the time necessary to complete the audit and seeks to minimize inconveniences to the taxpayer. Whenever possible, taxpayers will provide records to an auditor in excel (.xlsx) or PDF format.
During an audit, an ADOR auditor will examines and compares various sources of data. This includes payroll registries, ledgers and summaries; annual payroll reports; deposit statements; federal and state withholding tax and unemployment tax returns and annual reconciliation reports; corporate income tax returns; partnership tax returns; sole-proprietor tax schedule; W-2s, W-3s, W-4s, A-4s, and 1099s; 941, 940, and W-2s attached to individual employees’ income tax returns; cash disbursements journal, employee expenses and reimbursements journal; charts of accounts; and other payroll or financial records.
Assessment is determined by an ADOR auditor looking at discrepancies or inconsistencies and comparing the different sources of data to determine if the wages and tax withheld from employees were correctly reported to the Department. Correspondence and phone conversations with the taxpayer or taxpayer’s appointee will often take place to answer questions, and to make sure the auditor understands the taxpayer’s payroll reporting practices and documentation.
The auditor then shares findings with the taxpayer and allows the taxpayer input into the process. The auditor then determines the underreported amounts, discusses with the taxpayer and may provide a draft assessment for discussion.
Finally, a proposed assessment with accompanying work papers will be produced and sent to the taxpayer.
The Notice of Proposed Assessment informs taxpayers that the deficiency becomes final 45 days from the receipt of this notice unless an appeal is submitted to ADOR as indicated on the enclosed Taxpayer Response Form. Along with the response form, a survey form will be enclosed with the assessment as well.
The Arizona Department of Revenue, charged by state law, imposes penalties in the cases of late filing and late payment and is given the option to assess additional penalties at its discretion. According to statute, the Department must also assess interest on any unpaid tax according to federal and state adopted interest rates compounded annually.
The late filing penalty is assessed at 4.5% per month, or any part of a month, on any unpaid tax from the due date of the return until the return is filed, not to exceed a total of 25%.
The late payment penalty is assessed at .5% per month, or any part of a month, on any unpaid tax from the due date of the tax to the date the tax is paid, not to exceed a total of 10%.
The combined late filing and late payment penalties cannot exceed a total of 25%.
The failure to furnish information penalty is imposed when a taxpayer proves uncooperative in providing requested documentation. A.R.S. § 42-1125 (C) allows the Department to apply a 25% penalty to any deficiency tax assessed.
Other optional penalties can also be assessed if appropriate. Taxpayers can see the penalty statutes: A.R.S. § 42-1125
And they can learn more regarding interest here:
With a proposed assessment, the taxpayer also receives a customer satisfaction survey. The survey provides an opportunity for taxpayers to comment on the overall quality of service during the audit process. Additionally, taxpayers can also make suggestions to help us improve as a state agency. We encourage taxpayers to complete and return the survey to us.
To determine payment arrangements, a taxpayer will have to contact ADOR’s Collections Department.
Taxpayers should note that if they return their Taxpayer Response Form indicating they agree with the audit assessment, the 45-day protest period can be closed, allowing Collections to deal with a taxpayer regarding a payment plan. If a taxpayer fails to return the Taxpayer Response Form, a payment arrangement plan will not be able to be negotiated until the 45-day protest period has elapsed.
If a taxpayer disagrees with the audit findings, they have 45 days from the receipt date of the proposed assessment to file a timely appeal. This appeal should be submitted using the Taxpayer Response Form, which will be included with the audit assessment. On this form, the taxpayer may check that he or she agrees with the audit and return it to the auditor to expedite the process. Otherwise, the taxpayer may check a box disagreeing with the audit, and then provide a written explanation as to why he or she believes the assessment is incorrect.
Taxpayers can request to have an informal conference with the auditor and the audit manager, either at ADOR in person or by phone. Otherwise, the taxpayer can check a box requesting a formal hearing. The form is then returned to the auditor.
If the taxpayer requests an informal conference, the auditor will contact the individual to set up a date and time. If the taxpayer prefers a formal hearing, the response form will be forwarded to ADOR’s appeals unit. A representative will then contact the taxpayer. If an informal conference is conducted and the taxpayer still disagrees with the Department’s findings, the taxpayer’s appeal will also be forwarded to our appeals unit.
After an audit, an auditor issues a notice of proposed assessment. A taxpayer has 45 days to protest the assessment. If a taxpayer chooses a formal hearing, or if he or she disagrees with ADOR at the end of an informal conference, the taxpayer presents his or her protest to a neutral fact-finder before an administrative law judge (ALJ) at the Office of Administrative Hearings (OAH).
These Arizona Revised Statutes (A.R.S) set forth a framework for the administrative process:
- A.R.S. § 41-1092.02 lists agency actions exempt from application of provisions of the Administrative Code
- A.R.S. § 41-1092.02(A)(10) exempts actions by ADOR regarding income tax or withholding tax and any tax issues related to information associated reporting of income tax or withholding tax unless the taxpayer requests that this article apply and waives confidentiality under Title 42, chapter 2, article 1.
- A.R.S. § 41-1092.03 applies to actions involving TPT and addresses procedures for a hearing or informal settlement conference.
- A.R.S. § 42-1251 establishes time frames for appealing to the department (45- and 90-day periods) by filing a petition for a hearing, correction or redetermination, including an option of paying the total deficiency assessment, interest and penalties and filing a claim for refund within six months of the payment or the statute of limitations.
- A.R.S. § 42-1255 addresses the burden of proof.
- A.R.S. § 42-1254 addresses the process of appealing to the Tax Court.
- Arizona Administrative Code, Title 15, Chapter 10: Department of Revenue – General Administration
- Article 1. Appeal Procedures
- R15-10-101: Definitions
- R15-10-102: Scope of Article 1
- R15-10-103: Taxpayer Hearing Rights
- R15-10-105: Petition
- R15-10-106: Incomplete Petition
- R15-10-107: Timeliness of Petition
- R15-10-110: Withdrawal of Petition
- R15-10-115: Request for Hearings; Waiver
- R15-10-116: Hearing Procedure
- R15-10-117: Evidence
- R15-10-119: Stipulations of Fact
- R15-10-120: Official Notice
- R15-10-121: Subpoena by Petitioner
- R15-10-122: Transcripts and Records
- R15-10-130: Decisions and Orders
- R15-10-131: Review of Decision of the Hearing Officer or ALJ
- Article 2. Administration
- R15-10-201: Closing Agreements Relating to Tax Liability.
- Article 1. Appeal Procedures