So, your company or your client got audited by the Kentucky Department of Revenue and you find out that it is not going to be a “no change” audit, and instead, the Department has informed the taxpayer that they are going to receive an assessment. What do you do?
The Tax Audit
First, be on the lookout for one or more Notices of Tax Due in the mail. The first page about two thirds of the way down identifies it as a “NOTICE OF TAX DUE” along with an admittance advice that may be mailed with payment to the Department. Obviously, the Department is trying to make it easy for a taxpayer to pay the Notice. Of course, if a taxpayer does not want to protest the Notice, the taxpayer should promptly pay it to avoid the accrual of additional interest and collection action.
Next, review the Notice. The very top of the Notice includes the notice date, tax period, case number, notice number, taxpayer ID, type of tax, and taxpayer name. The Notice then identifies a contact with the Department, followed by a brief explanation, which often continues on the next page. Depending on the type of tax (e.g., income, limited liability entity tax, sales tax, etc.), the continuation on the next page may include a more detailed calculation of tax, interest and penalties due as well as the date that the protest is due and where to send the protest. Make a note of when the protest is due!
The back of the first page of the Notice includes: Rights of Taxpayer; Revenue Department Responsibilities; Where to Get Assistance; and Protest and Appeal Procedure. The Department includes this information not only to be helpful but also because the Kentucky Taxpayers’ Bill of Rights requires it.
Especially when the Department has conducted a field audit, the Department should also provide a copy of the audit workpapers and narrative which describes the grounds upon which the assessment is made. If these are not provided, they should be requested. This is because, as a practical matter, reference to the audit workpapers and audit narrative is necessary to determine the basis for the assessment.
In addition to Notices being issued as a result of a field audit, Notices may also be issued by a taxing area (e.g., income tax or sales tax) as a result of a desk audit.
When reviewing the Notice and supporting audit workpapers and narrative, look for not only items of disagreement but also mathematical errors.
The Protest
Be sure and check out the Department’s regulation concerning protests, 103 KAR 1:010.
Ensure that the protest is timely filed. A taxpayer must protest a notice of tax due within 60 days of the date of the notice; otherwise, the assessment becomes final, due and payable. KRS 131.110(1). Not only is it important that the protest be timely filed, it is just as important to be able to prove it. So, chose a delivery method that can readily do that.
The taxpayer or a representative of the taxpayer may file the protest. If a representative files the protest, the representative should furnish a “Declaration of Representative,” Form 20A100.
The protest must be in writing. A best practice is to not only include the magic words “protest” on the protest but to also make it clear that the protest is a protest and identify the Notice or Notices therein and attach them to the protest. The protest must also be accompanied by a supporting statement setting forth the grounds upon which the protest is made. KRS 131.110(1). The time for submitting the supporting statement may be extended if the delay is necessary and unavoidable. Id. Best practice is to file the protest and supporting statement together and within the 60 days.
When Notices are issued by a taxing area, there is an option to transfer the protest to the Division of Protest Resolution.
Another best practice is to request a protest conference in the protest.
The Supporting Statement
The supporting statement should address the items of disagreement including any mathematical errors. It should set forth the material outcome determinative facts and ideally compellingly explain how the law applies to those facts so that the Department will agree with the taxpayer’s arguments and adjust the assessment accordingly.
It is important to identify and raise all items of disagreement, not only substantive disagreements of tax due. The supporting statement should address, for example, the statute of limitations and any constitutional issues. Likewise, if the Department has assessed penalties, the supporting statement should raise this issue and request a penalty waiver or abatement, addressing reasons therefor provided in the regulation concerning waiver of penalties, 103 KAR 1:040.
The Protest Conference
An important part of the protest process is the protest conference, which a taxpayer may request. To ensure that a taxpayer gets the opportunity to have a protest conference, the best practice is to generally request a conference; however, exceptions may be small dollar protests or a protest limited to a waiver of penalties.
A protest conference is a great opportunity for the taxpayer to have a dialogue with the Department. It is often a great time to discuss an agreed resolution of the protest, i.e., a settlement, though a settlement may also be reached through corresponding with the Department.
In person protest conferences are often the most effective in moving the protest to a resolution.
The Settlement
Protests do not necessarily require concessions by the Department, the taxpayer or both to resolve the protest. However, for the Department to settle, the Department must recognize that it has hazards of litigation. KRS 131.030. In fact, “The department is encouraged to settle controversies on a fair and equitable basis and shall be authorized to settle tax controversies based on the hazards of litigation applicable to them.” KRS 131.030(3).
The topic of settlement may be raised by the taxpayer or the Department. Either party may tender an offer of settlement to the other. Sometimes, this is done verbally during a protest conference, but the Department often prefers to have a written offer of settlement. Often, settlement discussions result in a resolution, but not always.
The Final Ruling
If the protest is not resolvable, the next step is for the Department to issue a final ruling to the taxpayer.
KRS 131.110(3)(a) prescribes the final ruling procedure and the contents thereof: “After considering the taxpayer’s protest, including any matters presented at the final conference, the department shall issue a final ruling on any matter still in controversy, which shall be mailed to the taxpayer. The ruling shall state that it is a final ruling of the department, generally state the issues in controversy, the department’s position thereon and set forth the procedure for prosecuting an appeal to the Board of Tax Appeals.”
If the Department “cannot resolve” the protest, the Department will issue a final ruling. 103 KAR 1:010 § 5. On the other hand, a taxpayer may request a final ruling, in which case, the Department must issue the final ruling within 30 days. KRS 131.110(4). Like the Department, taxpayers generally request a final ruling after they have determined that the protest is unresolvable.
The final ruling is a “ticket” to appealing to the protest to the Kentucky Board of Tax Appeals. If the taxpayer does not timely appeal, the assessment becomes final, due and owing. KRS 131.500(1)(a).
If you disagree with an audit assessment, you can protest it!
This is a modified version of Mark A. Loyd’s regular column, Tax in the Bluegrass, “Protesting a Kentucky tax audit” which appeared in Issue 1, 2024 of the Kentucky CPA Journal.
