November 2003

Statistical Sampling in Sales and Use Tax Audits

By Will Yancey

CCH Incorporated; 203 pages; $75.00; ISBN 0808008099

Reviewed by Stephen J. Bercovitch

Statistical sampling is appropriate in sales and use tax audits at the two opposite extremes of recordkeeping: when the taxpayer’s records are so voluminous that sales tax transactions’ examination, evaluation, and review would not be feasible; or when the records are thin to nonexistent. In this volume, Will Yancey succeeds quite well in addressing the statistical sampling issues that may arise for the high transaction volume business taxpayer. His expertise is evident throughout the book, yet he explains the issues such that any member of a large- or medium-sized company’s tax department charged with conducting computerized sales and use tax audits can follow them.

The author places the sales tax sampling matter squarely within the broader context of today’s commercial environment. Increasingly, state revenue departments are relying on computer audit specialists in performing sales and use tax audits. Because of the Internet, more companies make sales over a wide spectrum of local jurisdictions with varying tax environments. Yancey conveys a good understanding of the negotiations that may occur with a taxing jurisdiction over the testing and estimation of these liabilities. He also mentions the key issue of overpayments sampling. Although overpayments are errors, too often a state refuses a refund claim to be filed on the audit, and instead requires separate refund claims to be made.

The book begins with an overview and discussion of computer-assisted sampling. Sections are devoted to the fundamental steps in the audit plan’s development; sampling objectives; and common problems, such as incomplete documentation, accounting system and personnel changes, and the development of taxability ratios. The book includes a good discussion of population characteristics and the inevitable issues that arise concerning the relationship of the sampled transactions to the whole.

Yancey also discusses some of the many nonstatistical judgments that can drive a computerized sales and use tax audit. Ultimately, both the auditor and the taxpayer will need to deal with many complex practical problems, such as changes in laws and regulations over the audit period term, changes in business operations that may color given transactions’ taxability, and changes in accounting and accounting systems.

Inevitably, projection methods that take statistically sampled results and compute a total error or tax liability in a transaction target population contain some slippage. Quantifying the true divergence between the ultimate projected tax liability and the “true” error or liability residing in the total population with any degree of statistical confidence is difficult. To address this issue, the author conscientiously furnishes no fewer than five different methods by which estimation and projection might be made to more closely align with true tax liability.

One of the book’s few drawbacks is its occasional tangent into statistical jargon; there is material here for a statistician or mathematician to examine regression formulae Sigma-computations, for example. These artfully segregated sections, however, can be perused or ignored as desired. The book’s versatility may give some readers pause, because Yancey is as adept at discussing the coefficient of variation, mean per unit, and regression as he is with garden-variety issues such as reconciling tax accruals to tax returns and tracing credits and refunds.

The statistical jargon notwithstanding, the book is far from abstruse or inaccessible. A practitioner can make use of the many practical judgments that inform a normal sales and use tax audit. For example, Yancey appropriately notes that sales and use tax auditors need to get their “hands dirty” with lots of “messy data” problems, and suggests that company representatives can gain credibility by voluntarily uncovering and explaining them. He correctly suggests that problems such as multiple transaction line items, missing data for some time periods, local jurisdiction coding errors, price adjustments, or product returns where sales or use tax might not be reversed, are issues that should be addressed up front.

The editors devote half of the volume to a comprehensive general reference bibliography and a state-by-state compilation of tax laws, decided cases, rulings, and regulations. Ironically perhaps, the decided litigation in this area is not in the area of computer-assisted audits, where the taxpayer had voluminous records and statistical methodology that produced a distorted result. Instead, the New York cases that the author cites are either cases that disallowed the auditor’s sampling methods when the taxpayer had adequate records, or cases where the auditor’s “sampling and projection method” was a one-day observation of a business’ operations—an indirect estimation method that appears almost humorously inadequate next to Yancey’s erudite discussion of mean and standard deviation.

The reader can easily draw from this volume the appropriately tailored advice and references, at whatever level meets the specific audit’s needs. That is what makes it a useful and practical addition to any accounting toolbox.

Stephen J. Bercovitch, JD, is a state and local tax counsel with Amper, Politziner & Mattia, P.C., in New York City.

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