Sales and Use Tax Audit Sampling

Published on August 12, 2016

Business taxpayers sometimes face surprisingly large sales and use tax audit assessments when the tax or taxable amount is projected from seemingly small and infrequent errors in the auditor's sample. Depending on how the sample is designed and weighted, large audit assessments can either reasonably reflect the taxpayer's actual facts or unintentionally be in error due to the sampling methodology itself. Many taxpayers are not equipped to evaluate the appropriateness of a jurisdiction's methodologies and projections and do not know whether or how to challenge them.

Sampling methodologies vary by state. Most states administer sales and use tax audits covering statewide and sub-state jurisdictions at the state level. While there are similarities, each taxing jurisdiction follows its own independent sampling methodology.

Types of Sampling

In general, state sampling methodologies fall into one of two categories: non-statistical (judgment and block) and statistical (stratified random) sampling.

Judgment sampling: This involves the selection of categories or dollar-size groupings of transactions to audit. This approach may be considered somewhat arbitrary because the selection is not random and has the potential of achieving a biased (or unrepresentative) result. A biased sample can result in either an over- or underassessment of the final amount of tax due. More importantly, there is no clear way to measure the bias or uncertainty. If, however, a small number of records make up a substantial amount of the total dollars under audit, it may be more efficient to follow this approach.

Block sampling: This takes the selection process one step further and focuses the sample on one or multiple time periods (blocks) of transactions. This can work reasonably well or quite poorly, depending on factors such as seasonality. Tax assessments identified in the block sample are projected back to the rest of the time period under audit.

Statistical, stratified random sampling: This is the most widely used approach. Random numbers are assigned to each record—such as a transaction or an invoice—in the population; the population is stratified by some predetermined category or dollar size; records assigned with the lowest random number within each stratum are selected; and, after review, errors in taxability or tax are statistically projected back to the population.

Conclusion

Sampling frequently is used by state and local tax authorities for sales and use tax audits. While stratified random sampling is the most widely used approach, each state has its own unique guidance for sample design, implementation, and extrapolation. It is beneficial for taxpayers to become familiar with sales and use tax audit sampling techniques used in jurisdictions where they operate. The state's sampling method will affect how the final audit assessment is ultimately determined.

(Source: AICPA – CPA Letter Daily - The Tax Adviser – July 28, 2016)