Sales-and-use tax audits rarely involve auditors poring over every invoice a business has generated in the last three years. Instead, most state taxing agencies, including the California Department of Tax and Fee Administration (CDTFA) and the taxing authorities of dozens of other states—rely on “sampling and testing.” If you operate a retail or service business, particularly one with thousands of small transactions, understanding the mechanics of sampling and testing is critical. Done correctly, sampling can produce a fair estimate of your tax liability. Done poorly or left unchallenged, a sampling can inflate that sales tax liability and threaten your cash flow, credit access, and even the survival of your company. If you have questions or concerns related to a sales tax audit, it is in your best interest to contact an experienced sales tax attorney as early in the sales tax audit process as possible.
Why Agencies Use Sampling
Generally, state sales-tax divisions have limited staffing. Reviewing every single transaction for a busy retailer could take weeks, cost taxpayers money, and bog down the agency’s workload. Sampling offers a statistically defensible shortcut. By choosing a representative subset of transactions, auditors extrapolate errors they find in that sample to the entire audit period. When the underlying math is sound, the government saves resources and the business avoids a drawn-out sales tax exam. When the math is flawed, the results can be disastrous. For example, a 3 percent error rate in a small sample could translate into thousands of dollars in projected under-collected tax across millions in gross receipts.
Common Sampling Techniques
Stratified Random Sampling
Auditors divide transactions into “strata” (often by dollar amount or transaction type) and then randomly select items from each stratum. Larger transactions may be tested 100 percent because they represent a bigger risk of tax loss; small-dollar sales might be sampled more lightly.
Systematic Sampling
The auditor starts at a randomly selected point in a ledger and then reviews every “nth” transaction—say, every 50th sale. Over a large data set, systematic sampling tends to approximate random selection.
Block Sampling
Here an auditor might choose a specific month or quarter as a proxy for the entire audit period. While easier to manage, block sampling can be dangerous if the selected block was unusually error-prone (for instance, because a new cashier was poorly trained).
Judgmental Sampling
Although less common, an auditor occasionally relies on professional judgment to target transactions perceived as high risk. Because judgmental samples lack statistical safeguards, courts often view them skeptically.
The Error-Projection Formula
Once errors are identified (e.g., missed sales tax on certain out-of-state shipments), the auditor computes an “error rate” by dividing the misstated tax by total tax in the sample. They then multiply that rate by taxable sales for the full audit period to project a total deficiency. Interest and penalties apply to that projected figure, not just the amounts actually identified in the sample.
How Businesses Should Respond
Initial Conference
When you receive a notice indicating your business has been selected for a sales tax audit, you have a chance to discuss sampling parameters. Bring organized transaction data, because auditors will generally negotiate the sampling frame.
Verify Sample Representativeness
Ensure the sampling period reflects “normal” operations. If your point-of-sale system was down one month, creating manual errors, push back on using that month as a proxy.
Reconcile Exceptions
Auditors often misclassify exempt sales (e.g., sales for resale) because supporting certificates were missing from the initial file. Provide documentation promptly to reduce sample-error counts.
Engage Statistical Expertise
When six- and seven-figure liabilities are on the line, hiring a statistician or a dually licensed Tax Attorney-CPA can pay for itself by identifying flawed extrapolations that could cost your business an arm and a leg.
Legal Standards for Sampling
Courts have generally upheld sampling so long as it is reasonable and properly executed. Yet courts also emphasize fairness. A taxpayer must have an opportunity to contest both the methodology and the numerical results. If the auditor refuses to disclose their calculations, you have grounds to protest.
Consequences of Accepting a Bad Sample
A projected sales tax deficiency becomes a final assessment if you do nothing. Uncontested assessments generate liens, hurt credit relationships, and trigger collection actions such as bank levies or asset seizures. Worse, under-collected sales tax is a trust-fund liability: owners and responsible officers can be held personally liable, meaning your house or personal bank account is on the line even if the business folds.
Your Best Defense
Businesses that survive sales-tax audits do so by staying organized, understanding how sampling works, and enlisting experienced counsel. At the Tax Law Offices of David W. Klasing, we can challenge flawed sampling, negotiate reduced error rates, and, when appropriate, propose alternative sampling plans. Because our practice is led by a dually licensed attorney-CPA, we appreciate both the legal and accounting dimensions of your case, positioning you for the best possible outcome.
If you have received notice of a sales-tax audit or just want to prepare before the auditor arrives—contact the Tax Law Offices of David W. Klasing for guidance. A proactive approach can reduce exposure, speed up the process, and keep your business on track.
