Publication Date - June, 2005
* Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and the Treasury Regulations.
NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.
8. SAMPLING METHODOLOGIES
In certain cases, use of sampling methodologies may be a desirable examination tool. Sampling is quite often used in research credit cases for greater audit efficiency. In fact, sampling should be considered in a research credit case whenever excessive amounts of time or resources are anticipated in examining all of the taxpayer’s expenses or projects.
We are aware of instances where statistical sampling has been employed to determine eligibility of such items as qualified wages, supplies, or contract services in the preparation of a tax return or claim. The Service’s position of the application of such method is as follows:
Under Treasury Regulation § 1.41-4(d), a taxpayer claiming the research credit must retain records in sufficiently usable form and detail to substantiate that expenditures claimed are eligible for the credit. Guidance on record retention is set forth in Treasury Regulation § 1.6001-1. If statistical sampling methods are discovered as the basis for determining return preparation or Claim filing amounts, the validity of the statistical sample must be confirmed by a CAS. Also, the scope or depth of the examination is not limited to the statistical sample items. The proper nexus between qualified expenses and activities must be established. The examiner is still entitled to request and receive records that will sufficiently substantiate all expenses and activities to which the credit claim relates, even if it is outside of the records maintained for the sample itself.
When a sampling technique is contemplated, the examiner, along with a CAS, should meet with the taxpayer and design a sampling plan that will result in an acceptable number of items to examine. The formulation of questions, questionnaires, or surveys to be used should be customized to each taxpayer’s specific circumstances. Specific sampling procedures should be thoroughly documented. While a judgment (non-statistical) sample will often require less examination work than a statistical sample, a judgment sample generally requires taxpayer assent as to how results the judgment sample results will be applied, while a valid statistical sample does not. Agreement between taxpayer and examiner should be negotiated in the early stage of the examination, and should generally be set forth in a closing agreement (Form 906), binding the parties to apply the results of the agreed-upon methodology. Local counsel can provide assistance in the formulation of closing agreements.
If agreement is not secured, the taxpayer and the Service may not be bound to adhere to the sample results. Thus, if a taxpayer initially agrees to the use of a non-statistical sampling methodology and later objects, absent a closing agreement, any adjustments based upon the judgment sampling methodology may not be sustainable in court. For this reason, it may be necessary to apply statistical sampling in cases where the parties cannot agree on an appropriate judgment sample or sampling methodology.
It is important to note that the use of such alternative sampling methodologies may be limited, as in the case where a taxpayer has filed a claim for refund that may be subject to Joint Committee Review. Therefore, it is critical that examination methods are carefully assessed and selected based on appropriateness to the type of activities, accounting systems and records maintained by the taxpayer on a case-by-case basis.