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 the state), so sampling is the logical alternative.

Chapter 3

Sales Tax Audit Sampling: What You Need to Know

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. But there is a risk that the sample will not be representative.

There are two different approaches to handling this.: non-statistical sampling and statistical sampling.

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.

Non-Statistical Sampling

To compensate for the uncertainty in non-statistical samples, most states select substantially more transactions than achieving an accurate statistical sample would require.

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.

Expanding the sample size frequently results in a more homogenous sample. But it does so 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 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 one district use statistical sampling:

  • 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

All of these states use non-statistical sampling on some, but not all, of their sales and use tax audits.

Statistical Sampling

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).

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.

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 they might not know 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 ]the auditor will use.

Once an audit has been completed or nearly completed, it is very difficult to change the sampling methodology used. This is because the auditor will usually have in their files a copy of an official notification they created for the taxpayer explaining the sampling methodologies in detail.

It’s rare, but possible, to redo a sample. We have been successful in getting the auditor to throw out and redo a sample 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 easier to review it carefully at the beginning.

If you can’t redo the sample, there are other ways to make sure the sample does not hurt your company unduly:

  • Watch out for sample periods that clearly do not represent an average month or day or year (depending on what unit the auditor sampled).
  • 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).
  • Be sure the auditor gives you credit for negative transactions that appear in the sample base that relate to taxable items.

Audit Sampling: the Bottom Line

The audit sample is a complex but critical part of the audit process. Understanding sampling methodology is important because a mistake here could cost you. If you’re not confident with your experience in dealing with this type of issue, we recommend bringing in an expert on to help.