Chapter three

Sales Tax Audit Sampling: Here's What You Need to Know

Almost all state taxing agencies use some form of sampling in their audits. Sales and use tax audits rarely span less than three years, so huge amounts of data can be subject to scrutiny. Detailed verification is neither practical nor desirable (for you or for the state), so sampling is the logical alternative.

FAQ ► Can States use sampling? Is this a good or bad thing? What specific questions should we ask about the state’s sampling procedures?

In businesses that have hundreds of thousands of sales or purchases, it is simply not feasible for an auditor to examine each sale or purchase invoice. Instead, some kind of sample must be chosen. Ideally, the sample or portion of invoices to be examined will be representative of the entire invoice population. There is a risk that the sample will not be representative. The difference between statistical and non-statistical sampling is that in statistical sampling the risk is quantified. In non-statistical sampling the risk is not quantified, but is left to the professional judgment of the auditors performing the examination. Consequently, in non-statistical sampling it is impossible to know whether the sample is too large, too small, or how accurately it reflects the records as a whole. 

Sampling Methods

To compensate for the uncertainty in non-statistical samples, most states select substantially more transactions than would otherwise be required to achieve an accurate statistical sample. Expanding the sample size frequently results in a more homogenous sample but at the expense of the taxpayer’s and auditor’s time.

Block sampling is the most commonly used example of non-statistical sampling. In block sampling, the auditor chooses a block of time (weeks, months, days) of checks, invoices, or vouchers to examine. The auditor assumes that the block of time of checks, invoices, and so on is representative of the entire population. An error rate is determined from the sample chosen and then extrapolated over the entire audit period. There is no way of measuring the accuracy of such a method.

According to our research, the following 26 states and the District of Columbia use statistical sampling on some but not all of their sales and use tax audits: Alabama, California, Colorado, Connecticut, District of Columbia, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, New Mexico, New York, North Carolina, North Dakota, Ohio, Pennsylvania, South Carolina, South Dakota, Tennessee, Utah, Washington, and Wisconsin. All of the states continue to use non-statistical sampling in some, if not most, of their audits.

TIP ► If given a choice, in most audit situations, you should opt for statistical sampling.

While statistical sampling generally involves more up-front work, it results in an assessment that is usually more reliable, because it’s repeatable. Non-statistical sampling is not repeatable and may be grossly overstated (or understated also). 

In any case, you should thoroughly discuss the proposed sampling methodology with the auditor until you understand what they’re proposing to do. You and the auditor may be able to reach an acceptable compromise on the type of sampling done. Waiting until the audit has been completed to object to the sampling methodology is a failed strategy that has been rejected in many court appeals.

Sampling Methodology Agreements

The sampling methodologies that the auditor wishes to use are usually agreed upon very early on in the procedure. Many times the taxpayer agrees to a particular type of sampling without clearly understanding what the auditor is attempting to do and without knowing what records are available and what types of purchases were made during the time periods being sampled. If your audit is a sample audit, you should carefully evaluate the sampling methodology to be used by the auditor.

Once an audit has been completed or nearly completed it is very difficult to change the sampling methodology used. This is true because the auditor will usually have in his/her files a copy of an official notification they created for the taxpayer explaining in detail the methodologies they used in performing the sample audit. We have been successful in getting the sample thrown out and redone by a new auditor in a number of audits. Each time we were successful, it was because the sampling used was clearly egregious. In each case, the final tax assessment was greatly reduced. But it was a hard-fought battle every time to get the samples thrown out. It’s best to review it carefully at the beginning. 

TIP ► It is not always necessary or even desirable to get samples completely thrown out.

There are other ways to make sure the sample does not hurt your company unduly. For example, watch out for periods being sampled that clearly do not represent an average month or day or year (depending on what unit the auditor sampled). Also, watch out for extraordinary purchases showing up in the sample. These can skew the audit against you in some cases (or for you in others). Finally, be sure the auditor gives you credit for negative transactions that appear in the sample base that relate to taxable items. If you’re not confident with your experience in dealing with this type of issue, we recommend bringing in an expert on this aspect to help.

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