Sales Tax Audits and Sampling
Questions arise frequently around what is allowed (or mandated) when it comes to sampling. Just about every state uses sampling in conducting audits. The question is, do the states use "statistical" or "non-statistical" (or both) audit methods. Some of the non-statistical methods that states use are actually different types of block sampling methods. Some states use a time period such as a month or several months or year(s) and then project what they find in the sampled time period to the whole population of transactions in the entire audit period. Other non-statistical block methods that some states use are the voucher, invoice or check sequence methods where they choose every nth voucher, invoice or check number for the sample. The least frequently used method is the alphabetical method.
Best to Look at Sampling Issues Up Front
The block methods have the advantage of being fairly simple to set up and to execute. However, they are also notorious for generating inaccurate results. Sometimes the inaccuracy is to the benefit of the taxpayer, but it seems all too infrequently that block samples hurt the taxpayer. This is probably attributable to the fact that the auditor does this all of the time and knows what to look for and usually has a feel for what will generate the best results for the state. It pays to have an expert advise you when an audit is to be done on a sample basis. What accounts will the auditor select (will the selected accounts target only areas where underpayments are likely to be found and not include other accounts where tax could possibly be overpaid?) and what type of sampling method will the auditor choose and what time period is involved. These are all crucial issues to address up front.
It's better of course to have a say in what sampling method the auditor will use before the audit even begins. Here's one tip to use if you are still in the beginning stages of an audit. If your state audit will be conducted using a block sampling method using a time period, then you would do well to analyze your purchases and sales by month. You can compute what your monthly and yearly averages are. Then as you compare other months you will see if they fit the pattern for "normal" months and years. Armed with that information, you can be careful in what time periods the auditor selects.
Another issue to consider when it comes to sample audits is whether the auditor will give you credit in the error percentage for items on which tax was overpaid. This is a key agreement to make before an audit begins. The idea is that if the state is actually interested in assessing your true tax situation in the population, then the sample error percentage must be corrected for overpayments. Not all states will do this, but it's worth discussing up front.
Must You Consent to a Sample Audit?
Certain states require you to submit to sampling while others ask for your consent. We have been involved in over 1000 sales tax audits over the years. A very high percentage of these audits are conducted using some aspect of sampling. Block or other non-statistical sampling can lead to widely varying assessments depending on what items happen to show up in the sample. Every sample should be evaluated for fairness. There are many ways to test audit samples after the fact. What you look for is large nonrecurring items that tend to overstate the actual error percentage in the population. The solution there is to remove those items from the sample and tax them in detail.
TAX MATRIX -- We have some tax matrices already put together based on survey questions made to the states each year. We offer this basic research to you at no charge for up to 10 states. If you like to receive one of these charts, please email us here and just request it. But remember, this chart is the result of a survey performed by the states and is research provided to us by CCH. The charts are fantastic resources, but cannot substitute for professional advice based on your specific facts and circumstances. By all means, have a look at the charts we can provide but then do your own research and consult an expert.
Top 4 questions:
Audits - Sampling
- Does State Use Sampling in Audit Assessments?
- If Taxpayer Maintains All Required Records, Must They Consent to the Use of Sampling?
- If Sampling is Used, What Areas Are Typically Examined?
- Does Your State Assess Taxpayers for the Costs Incurred in Conducting Out-of-State Audits?
What's the Best Way to Get Answers to Your State Tax Questions?
CALL THE STATE? -- This may not be the best thing to do. Clients frequently remark that when the call the state for guidance, they often get hazy and even conflicting answers. We usually say that it's not that people at the state don't know what they're talking about. In fact, if you get a hold of the right people with expertise in your industry, and they understand your question correctly, then you can almost always trust the answer you get from them. Just try to get the answer in writing, so you're protected in the event of a future audit.
But you have to get the right people and you have to phrase the question appropriately using correct terminology so that misunderstandings are avoided. Certain words carry meaning in the sales tax world that might not be immediately apparent to a non sales tax person. Sales tax is much more a "form over substance" type of tax than income tax and how things are worded in a contract or invoice can be crucial to the taxability. How a question is worded can also make a big difference. Don't get me wrong, I'm not saying there's some sort of trick or code language that you must conform to or else, I'm just saying that you want to understand all the implications of the words you choose in asking for guidance so that you get the most accurate answer.
Plus, how do you know if you got the whole answer on your situation? You may have described your facts and circumstances accurately but left out something that you did not think was important. The answer you get would be dependent on the facts you presented. But in reality, the answer you get may not be appropriate when you consider all the relevant facts.
GOOGLE IT? -- With so much information available on the Internet these days, you can Google your question and chances are, you'll find something that seems to match your situation. The problem here, of course, is, does this answer really apply to your situation? Is there another contradicting ruling or law on this matter? Has this item you found been superseded?
GET A RULING? -- What if there is no law, regulation, court case or state ruling that addresses your exact situation? Yes, this does happen and quite frequently. State revenue departments have not produced answers to every possible question. This is in stark contrast to the IRS, where it seems that no matter what situation you face, there is a regulation or revenue ruling or court case that addresses it on point -- it's just a matter of finding it. At the state level, we frequently run into situations where there is simply no documented answer to your question. In this case, we usually recommend obtaining private letter rulings from the revenue departments. Each state has their own procedure. We usually recommend only seeking a letter ruling where you have already discussed the question with a subject matter expert at the state, and gotten a pretty good idea of what you're going to get in the ruling. It's not always possible to do, but you don't want bad precedent, if you can help it.
ASK THE EXPERTS? -- Have you tried calling the state or just searching the Internet and came away wondering if you got the right answer? Have you considered asking an expert? You probably have, but hesitated, considering the cost. Well, this is what we do -- We Solve State Tax Problems.
And, we don't always charge for this service. How can that be, you ask? We subscribe to just about every service available and can find just about any law, regulation or court case that would bear on your facts and circumstances. And more than that, we use our many years of experience to evaluate your facts to form the correct questions. With that experience we can draw conclusions you can rely on. And we maintain contacts with key state personnel that we can confirm how the state will treat certain transactions that fall in gray areas.
Sometimes we just flat know the answer to a question you have. We always tell our clients: "If you have a question, just call us or email us. If we can answer you off the top of our heads, we're not going to charge you. If we need to do some research, we'll tell you before we do the work and seek your approval before we do it." You can expect no surprise invoices from us.
So What Questions Do You Have?
Like we said earlier, we can deal with any state tax question you can think of. Of course, the answer to many questions we get is, "it depends!" And that may sound like a cop out, but it really does depend. The answer depends on which state we're talking about number one and then on other possible variances in the facts. One of the helpful resources we subscribe to is provided by CCH. And one of the resources they give us access to are certain charts or tax matrices.
CAUTION ON CHARTS --A big word of caution is in order when it comes to charts. A chart is just a starting place when you want to do some research, and not the final answer by any means, but it's still interesting and insightful. One particular chart they provide is unique in that it is based entirely on surveys of actual state tax departments and as such it is a good representation of state tax policy. But it is just state policy and this survey is not binding on them. Sometimes, a state's own policy is at variance with the law, so take this with a grain of salt. But, it still makes for good state tax conversation. We're here to help, give us a call.