Statistical sampling: a potential win for business taxpayers.

• Author: Batcher, Mary
• Position: Tax returns

The IRS Large and Mid-Size Business (LMSB) Division has recently sought and received advice from Tax Executives Institute, the American Institute of Certified Public Accountants, and others on the appropriate guidelines for the use of statistical sampling in the filing of tax returns. Although this action has understandably created some apprehension for businesses, it is also an explicit recognition that taxpayers can use statistical sampling to allow them to claim deductions and credits they might not be able to claim otherwise.

The IRS has used statistical sampling as an audit tool for many years. At the same time, there was little acknowledgement that taxpayers could also use this tool, except in a few narrowly defined situations. Taxpayers, however, have been increasingly using sampling for the filing of tax returns in more and more situations.

Tax Sampling Situations

How can businesses use sampling for filing tax returns? Sampling should be considered whenever there are facts and circumstances determinations and the population is too large to review it in its entirety without incurring excessive costs and risking overtaxing the reviewers to the point of having a bad process. One example is the review of a sample of meals and entertainment expenses currently subject to a 50-percent limitation. The underlying invoices and other documentation are reviewed to determine a percentage of such expenses that can be reclassified to 100-percent deductible. That percent is then applied to the entire 50-percent limitation population. Statistical sampling has also been used on invoices from the earlier months of a taxpayer's fiscal year to determine a percentage that are related to work performed in the prior fiscal year. Another example is the use of a sample of records from documented costs associated with large fixed assets--property, plant and equipment--to determine which costs qualify as research or experimental and therefore are eligible for immediate deduction rather than for depreciation over a period of up to 39 years. In this case, the search is for detailed items, like carpeting, that are classified as 39-year property but can be depreciated over a shorter time. Sampling has also been used for many years for LIFO inventory determination, both to develop an index or to assign the inventory to published categories.

In addition to situations where the population is so large that it would be essentially impossible to review them all, there are also situations where the population may be moderate in size but the cost of processing each sample or population unit is high. An example is the determination of eligibility for the R&D tax credit. A sample of projects or employee wages can be used to determine the eligible amounts spent. The IRS frequently uses sampling to review R&D credit claims during the course of an audit.

In fact, it makes sense for businesses to consider sampling for filing returns in any situation where the IRS tends to use sampling for the audit of such claims. Another example is the sampling of business properties for cost segregation purposes. In this case, the population may be quite modest in size, a few hundred, but because of the high cost of processing each property, sampling can save several hundred thousand dollars over the cost of having engineers and architects look at each property.

As the foregoing examples demonstrate, sampling has broad applicability in tax and should be considered whenever deductions or credits might be left on the table because the population is too large or the cost is too high to look at everything.

Why Sample?

There is a common perception that sampling is...