Information technology is everywhere and, in many respects, it has made it easier for us to do our jobs and stay connected with friends and family. However, the rise of technology has also made it easier for federal and state governments to share information.
While states and the federal government historically had to rely on their own resources to uncover information about individuals and corporations, the electronic age has made information sharing agreements an easy and cost effective means of identifying compliance issues. For example, when a taxpayer is audited by the IRS and makes an adjustment to increase taxable income, the IRS will provide this information to the states with which it has an information sharing agreement. As a result, the taxpayer’s principal state now has the information to make an adjustment to a previously filed return and issue a tax bill.
Information sharing agreements are not new; they have existed in some form for at least 10 years. One of the most notable examples is the agreement between the IRS and states to share information about abusive tax shelter transactions. This agreement was seen as a watershed moment in the relationship between the IRS and states and it was viewed as an opportunity to extend the resources of all parties. Although many states have not passed specific legislation related to reportable and listed transactions, this information sharing agreement was viewed as an effective measure to strengthen tax administration and identify improper transactions.
While certain information cannot be shared between the IRS and states, it is realistic to expect that any information that can be shared will be shared. The IRS sends information related to common income types such as wage and 1099 income to the states with which it has a sharing agreement on a regular basis. However, the states that have agreements with the IRS are not uniform in how or when they respond to the information. Some may decide not to do anything, while others may take a more proactive approach and use the information they receive to issue a bill to the taxpayer which incorporates the change into a previously-filed return.
One thing is certain: states need money and a primary way to get it is through more stringent enforcement of current tax compliance rules and regulations. More and more states are investing in technology that will enhance their capability to utilize the data they receive and more efficiently administer their tax laws. Taxpayers should anticipate that the IRS will share information it obtains through an audit with states and that states are becoming better equipped to use this information to generate a notice or a bill. However, taxpayers will still need to be diligent in assessing whether an IRS adjustment will result in a state adjustment, as that is not always the case.