Texas Sales Tax Audit Sampling: When It’s Allowed—and When It Can Be Challenged

When conducting sales tax audits, the Texas Comptroller’s Office has the ability to use sampling rather than conducting a comprehensive review of an audit target’s sales tax payment history. While this might initially seem like a good thing—as it helps streamline the audit process—the reality is that sampling can present a variety of additional risks for businesses whose sales tax records are under review.  

As a result, businesses targeted in Texas sales tax audits will need to challenge auditors’ use of sampling in many cases. Here are some additional considerations:

The Texas Comptroller’s Office Has the Statutory Authority to Use Sampling

Regarding when audit sampling is allowed, it is allowed in all cases. This is made clear in Section 111.0042 of the Texas Tax Code. Additionally, the Texas Comptroller’s Office confirms that it will use sampling in the following scenarios (as expressly authorized under Section 111.0042):

• Detailed, Complex and Voluminous Audits – The Texas Comptroller’s Office uses sampling during sales tax audits when “[t]he taxpayer’s records are so detailed, complex or voluminous that an audit of all detailed records would be unreasonable or impractical.”
• Inadequate or Insufficient Records – If a taxpayer’s records, “are inadequate or insufficient, so that a competent audit for the period in question is not otherwise possible,” the Texas Comptroller’s Office will use sampling to project the taxpayer’s total sales tax liability.
• Costs of Full Audit Outweigh Benefits – If conducting a full audit would be “unreasonable in relation to the benefits derived,” the Texas Comptroller’s Office can use sampling in this scenario as well. However, in this scenario, the Office must first determine that “sampling procedures will produce a reasonable result.”

In line with these considerations, the Texas Comptroller’s Audit Manual directs auditors to consider sampling when: (i) “gross sales are numerous,” (ii) “gross sales are of similar unit value,” or (iii) “claimed deductions are numerous.” The Audit Manual directs auditors to consider stratified sampling if there is significant variation in a business’ price of units sold or if the business only occasionally has a “large sale.”

Challenging Sampling Before, During, or After a Texas Sales Tax Audit

So, that covers when sampling is allowed. Now, when can it be challenged?

While the Texas Comptroller’s Office relies on sampling to improve audit efficiency, sampling presents several potential issues. As a result, businesses targeted in sampling audits may have grounds to dispute the results of the sampling process. Some examples of potential grounds to challenge the use of sampling in a Texas sales tax audit include:

Failure to Follow the Requisite Procedures

When auditors use sampling during a Texas sales tax audit, they have an obligation to notify the business, “no later than after examination of 25% of the sample.” This notification must be hand-delivered “whenever possible,” and it must be delivered to the contact person specified in the business’ Audit Questionnaire. After completing the sampling process, auditors must also notify the business of “how errors are projected.”

Failure to comply with these procedural requirements (among others) can provide grounds to challenge the use of sampling. These requirements are intended to ensure that businesses have the opportunity to participate in the sampling process and make informed decisions about its validity. If a business does not timely receive the information it needs to intervene, this in itself can serve as grounds for an appeal.

Non-Representative Sample Selection

Sampling involves looking at a business’ sales tax compliance record during a chosen “test period.” The selected “test period” can significantly affect the validity of the sampling process. For example, the following issues (among others) could potentially lead to a grossly overstated assessment of a targeted business’ total sales tax liability:

• Selection of a sample period with one or more invalid exemption or resale certificates;
• Use of a sample period with above-average sales (i.e., a sample period that includes the holiday season); and/or,
• Use of a sample period with a one-off event that produced above-average sales.

For large businesses, each of these issues could potentially result in hundreds of thousands or millions of dollars in unwarranted sales tax liability. Yet these issues are common, leaving businesses forced to fight to avoid unwarranted liability in many cases.

Improper Projection of Total Sales Tax Liability

Along with selecting a non-representative sample, using improper methods to project a business’ total sales tax liability can also justify challenging the use of sampling during a Texas sales tax audit. As noted above, auditors are required to inform businesses of how they projected errors during the sampling process. If these methods are inappropriate under the specific circumstances at hand, an appeal may be warranted.

Again, these are just examples. Businesses can challenge the use of sampling on various other grounds as well, and those that take a proactive approach to defending against their Texas sales tax audits can challenge auditors’ methods before and during the process. While there are no guarantees, taking a proactive approach can help mitigate the risk of needing to file an appeal—and this can be the most cost-effective approach in the long run.

Sampling During a Managed Audit

Businesses that opt to undergo managed audits can use sampling during this process. While sampling during a managed audit generally presents fewer risks than during a traditional audit (because the audit is conducted by a representative of the business rather than an auditor working for the Texas Comptroller’s Office), there are still several practical and legal considerations. As a result, careful selection of the sample remains critical, and ensuring the use of appropriate means of projecting the business’ total sales tax liability remains critical as well.

Contact Us for More Information

If you need more information about sampling in Texas sales tax audits, we invite you to get in touch. To request an appointment with an experienced Texas sales tax lawyer at Brown P.C., please call 888-870-0025 or contact us online today.