Arkansas DFA Income Tax Audit Protest

The situation

Dana, 47, owns a Little Rock, Arkansas marketing consultancy (Ridgewood Creative LLC) with $890,000 in annual revenue and clients across Arkansas, Texas, and Tennessee. In February 2026 she received an Arkansas DFA Notice of Proposed Assessment: "Arkansas Corporate Income Tax: $28,400 (penalty $4,260 + interest $2,100 = $34,760 total), tax period 2022–2024."

The DFA auditor claimed Ridgewood Creative owed additional Arkansas income tax because the auditor applied Arkansas' full apportionment factor to all of the LLC's revenue, treating all $890,000 as Arkansas-source income, despite the fact that Ridgewood's Tennessee and Texas clients received services delivered partially by Tennessee-based contractors.

Dana has 60 days to file a written protest with the DFA Office of Hearings and Appeals.

(a) The apportionment calculation is almost certainly wrong. Under Ark. Code Ann. § 26-51-712, multi-state businesses apportion income using a three-factor formula (sales/services, payroll, property). The sales factor for service businesses uses destination-based sourcing, Arkansas-source revenue is only revenue from services delivered to Arkansas customers. Dana's Tennessee-client revenue should be apportioned to Tennessee, not Arkansas. The auditor appears to have used a 100% Arkansas apportionment when the correct figure is closer to 70-75%.

(b) Penalty abatement may eliminate $4,260 in penalties. Ark. Code Ann. § 26-18-208 provides penalty abatement for reasonable cause. Dana's first-time underreporting, caused by legitimate uncertainty about multi-state apportionment methodology, qualifies for a good-faith reasonable-cause argument. This alone is worth the protest filing.

(c) The two-stage protest path requires understanding the independent body. The DFA Office of Hearings and Appeals (OHA) is the first stage, it's internal to DFA, so its decisions may be biased. If the OHA protest fails, Dana can appeal to the Arkansas Tax Appeals Commission, an independent quasi-judicial body under the Inspector General, which is genuinely independent of DFA. Understanding this two-stage structure matters strategically: filing a weak OHA protest creates a poor record for the Tax Appeals Commission.

(d) A Mitchell Williams tax attorney quoted Dana $6,500 for "protest preparation and OHA representation." The apportionment recalculation + written protest + penalty abatement argument is self-executable with the right Arkansas-specific structure.

Who receives this

Arkansas small businesses (S-corps, LLCs, partnerships) with multi-state operations receiving Arkansas DFA income tax assessments for disputed apportionment, nexus, or deduction issues. Secondary: Arkansas sole proprietors and individual business owners receiving personal income tax assessments for underreported self-employment income or business deductions.

Why the agency will not advise you

Arkansas DFA cannot advise audit respondents on how to contest its own assessments. The OHA brochure describes the process without providing protest strategy. The Tax Appeals Commission's online filing system (ig.arkansas.gov) accepts petitions but provides no argument templates. Mitchell Williams, Wright Lindsey & Jennings, and Rose Law Firm are the incumbent professionals ($2,500–$10,000). No self-serve Arkansas income tax audit protest navigator exists.

Key facts, with sources

• The Arkansas DFA Office of Hearings and Appeals (OHA) receives written protests filed within 60 days of a Notice of Proposed Assessment. The OHA serves as an 'impartial decision maker between the Department and taxpayers.' If the OHA protest is unsuccessful, the taxpayer may appeal to the Arkansas Tax Appeals Commission, an independent quasi-judicial body under the Arkansas Inspector General, by filing a petition at ig.arkansas.gov/tax-appeals-commission/. The Commission accepts online filings and conducts hearings in-person, by teleconference, by videoconference, or on the documents alone. Further appeal from the Commission goes to Arkansas Circuit Court. The 60-day protest window is a hard deadline: missing it converts the NPA to a final and unappealable assessment. Source: Office of Hearings and Appeals — Arkansas Department of Finance and Administration · Tax Appeals Commission — Arkansas Inspector General · Taxpayer Bill of Rights — Arkansas DFA
• Arkansas income tax audits of businesses most commonly focus on: (1) multi-state apportionment, Arkansas uses a three-factor formula under Ark. Code Ann. § 26-51-712 (sales, payroll, property), and auditors dispute the Arkansas fraction for service businesses and digital companies; (2) nexus disputes, remote workers and sales representatives in Arkansas create income tax nexus under Ark. Code Ann. § 26-51-201; businesses may contest nexus under P.L. 86-272 (federal law protecting solicitation-only activities from state income tax); (3) S-corp and LLC passthrough owner assessments, DFA audits passthrough entity owners for Arkansas-source income underreporting when the entity has Arkansas-source income; (4) deduction substantiation, DFA routinely disallows business deductions absent adequate documentation. Arkansas imposes income tax at rates up to 4.9% (2025 rate, reduced from prior-year rates under ongoing Arkansas tax cut legislation). The penalty for underpayment of tax is 5% plus 5% per month up to 35%, plus interest. Source: A Review of Options for Taxpayers with Arkansas State Back Taxes — TaxCure · Individual Income Tax — Arkansas DFA

When to bring in a professional

Self-serve responses fit routine cases: clear facts, amounts a business can absorb, and a deadline still ahead of you. Bring in a licensed professional when the amount at stake is large relative to their fee, the facts are genuinely disputed, criminal exposure is possible, or the deadline has already passed. A short paid consultation to sanity-check your plan is often worth it even when you handle the filing yourself.

All sources for this guide

1. Office of Hearings and Appeals — Arkansas Department of Finance and Administration
2. Tax Appeals Commission — Arkansas Inspector General
3. Taxpayer Bill of Rights — Arkansas DFA
4. A Review of Options for Taxpayers with Arkansas State Back Taxes — TaxCure
5. Individual Income Tax — Arkansas DFA