Does Sampling Make Sense?
Does it make any sense at all that the Auditor would audit your sales, then, when it came time to look through all of your books and records, that they would only pick 1-3 months out of a given year and then estimate the sales and profits for the entire year?
If you think this is an entirely unfair and incompetent method, you are right. If you think this is fair, then you are probably an auditor for the State and enjoy getting paid for doing at best half your job.
How Sampling Determines Your Sales Tax Liability
1. Sampling for Gross Revenue
Sampling to determine gross revenue works like this:
The auditor takes your gross sales for January, June, and September for a given year. They will add up the three months and then take an average sale.
Example:
- January: $20,000.00
- June: $2,000.00
- September: $2,000.00
- Average Sale: $8,000.00
Do you notice the problem here? Our client in the example above is poised to make gross revenues of $96,000.00 in sales. Assuming the sales tax rate is 7%, their sales tax collection will be determined to be $6,720.00.
When the auditor takes the average sales figure, then applies the sales tax rate for your county, you are left with the balance owed per the Auditor. Obviously, penalties and interest will apply to the difference in what you collected versus the Auditor’s findings.
2. Estimating Prices
Estimating your prices is even more ridiculous. It works like this:
- The auditor will look to similar stores just like yours in your area.
- There is no clear indication of what the “area” encompasses.
- They compare prices at other businesses and suggest that you should be selling the items at the same price.
This does not take into account:
- Your clientele
- Sales
- Specials
- Giveaways
However, the auditor will use these prices and profit margins of other businesses and compare them to yours. If you sell for less, then the difference in estimated profits will be used to determine the difference in sales tax.
3. Estimating Cash Sales
I intentionally saved the best for last.
If all of your sales are on debit or credit card, then you are out of luck. The Auditor will compare the amount of cash sales of similarly situated businesses to your cash sales.
- If they determine that the number of cash sales in the area is 5%, then:
You are now considered to be hiding an extra 5% of your gross sales.
Again, tack 5% worth of gross sales to your liability and add penalties and interest.
The Bottom Line
As you can see, a sales tax audit can almost never go well without at least an appeal, if not a managed audit by a sales tax attorney.
You are guilty until proven innocent.
Frequently Asked Questions
What is sales tax audit sampling and why is it controversial?
Sales tax audit sampling involves reviewing a few selected months of financial data and extrapolating results across the entire year. It’s controversial because this method can misrepresent actual sales activity, especially if the selected months are not representative of typical business performance.
Can an auditor really estimate my prices based on nearby businesses?
Yes, auditors may compare your prices with similar businesses in your area, even without considering your specific clientele, promotions, or pricing strategy. This approach often leads to inaccurate assumptions and inflated tax liabilities.
How do auditors estimate cash sales during a sales tax audit?
If you don’t have significant cash sales records, auditors may assume you’re hiding income by comparing your business to others. If similar businesses have 5% cash sales, they may add 5% to your reported gross sales, increasing your tax obligation.
Is it legal for auditors to use estimated sales and profits to assess tax liability?
Yes, although it may seem unfair, auditors are permitted by law to use estimation methods when they believe records are incomplete or unreliable. However, these assessments can often be challenged through appeals or managed audits.
What should I do if I receive an audit assessment based on sampling?
You should consult a sales tax attorney immediately. Audit findings based on sampling and estimation are often inaccurate, and a professional can help you appeal or negotiate a fairer resolution.