EXTAX^®
Controlling and Recapturing Sales and Use Tax Overpayments

EXTAX® Special Topics:

• Projection of Credits Increases Texas Audit Recoveries
• Sales and Use Taxes a Key Issue for Clients
• Protesting a California Sales & Tax Audit
• Texas Sales & Use Tax Labor Partially Exempt During Phase-in Period

Projection of Credits Increases Texas Audit Recoveries

As most practitioners are aware, Texas S.B. 1319, through Sec. 151.430, allows taxpayers to use sampling and projection to quantify and recover overpayments of tax. In the past, credits could be projected only if selected as part of an audit sample. Now, the taxpayer has the authority to establish a separate sample specifically for this purpose, either in conjunction with a state audit or independently.

The practical effect of this change may not yet be fully appreciated. If the experience during a current Texas audit, however, is any indicator, this new law (which went into effect October 1, 1999) may increase recoveries of tax overpayments by as much as 30 percent! Here’s how:

In this audit (of a capital-intensive manufacturer), certain expense purchase accounts of interest were selected by the auditor for sampling. From this transaction population, six strata were established, with four to be sampled and two to be reviewed on a detail basis. Capital items were also to be reviewed on a detail basis.

Following receipt of the notification of sampling procedures, the taxpayer independently initiated a detailed review of all expense transactions, whether or not included in the auditor’s accounts of interest. A week was spent sampling transactions for overpayments of both sales and use taxes. (Sales tax overpayments may also be projected, and the taxpayer may now utilize the longer of its own or the vendor’s statute of limitations, including waiver extensions.) After the sampling, all transactions with vendors identified as likely sources of tax recovery were coded. A pivot table summary of these transactions by location and account revealed that the accounts of interest for the auditor were not necessarily the accounts of interest to the taxpayer! In fact, thirty or so "overpayment" accounts of interest were proposed to be sampled by the taxpayer and incorporated into the audit.

This proposal was accepted by the auditor, pursuant to Sec. 151.430. Another week was spent establishing strata for the population(s) and sample sizes. Samples were randomly selected using statistical software and the samples evaluated using Texas audit standards (sample mean within two standard deviations of the population mean, mean variance within fifteen percent, etc.). A size-sensitive summary of the expected result of this procedure is startling. The total expected tax recovery, stated in terms of transaction size strata, is as follows:

What this table shows is that of the over $1 million expected to be recovered, $226,000, or about 22% will come from transactions of less than $500. To recover this same tax on an actual basis would require a review of over 21,000 transactions with an average tax recovery of about $10 per transaction. Add these results to the next strata of transactions between $500 and $1,000, and over $395,000 will be recovered, nearly 40% of the total. To get the same result, 24,000 transactions would have had to be reviewed under the old law.

In fairness, a portion of these recoveries were included in the audit sample, so recovery using a sample could have occurred even under prior law. However, what if no audit was being conducted and what about the accounts not chosen by the auditor? Tax recoveries from the non-selected accounts of interest only are expected to be as follows: