Sampling for Income Tax

Contents of this page:

• Federal Cases
• Federal Statutes
• Internal Revenue Service - Rulings and Directives
• Internal Revenue Service - Training and Publications
• Journal Articles

• Auditing
• Data Mining
• Electronic Evidence and Records Retention
• Evidence and Expert Testimony
• Sampling in Financial Audits
• Sampling for Medicare and Other Claims
• Sampling in Sales and Use Tax Audits
• Sampling for Sales and Use Tax Audits - Bibliography of Review Articles
• Sampling for Valuation
• Sampling Theory
• Statistical Education and Software
• Statistical Evidence in Litigation
• Will Yancey's Home Page

Disclaimer:  Inclusion on this list does NOT imply the cited work is or was a good authority. This list is NOT an exhaustive list of the relevant literature.   Please email your suggestions for additions and changes to  will@willyancey.com

Federal Cases

• Kikalos v. United States, Docket No. 04-1613, http://caselaw.findlaw.com/data2/circs/7th/041613P.pdf (US Court of Appeals for 7th Circuit, May 24, 2005). Held that IRS use of an indirect method of estimating income did not preclude taxpayer from presenting alternative methods. Held that taxpayers are required to prove the IRS method is inaccurate and not that IRS method was irrational.
• Perkin-Elmer Corporation and Subsidiaries v. Commissioner, Tax Court Memo 1993-414, www.legalbitstream.com (September 8, 1993).   Taxpayer used statistical sampling to determine transfer prices.
  
• United States v. Davey, 543 F. 2d 996 (CA-2 1976). Taxpayer was not required to produce records that it did not keep in the ordinary course of business.
• United States v. Fior D'Italia, Inc., No. 01-463, 89 AFTR2d 2002-2883, laws.findlaw.com/us/000/01-463.html (US Supreme Court, June 17, 2002). IRS may use aggregate estimation methods to estimates tips allocable to restaurant employees).
• United States v. Mobil Corporation, 499 F.Supp 479 (N.D. Texas 1980). Taxpayer was not required to produce records in a format that it did not keep in the ordinary course of business.

Federal Statutes and Regulations

• Federal Business Records Act, 28 U.S.C. chapter 115, §§ 1731 - 1746, http://caselaw.lp.findlaw.com/casecode/uscodes/28/parts/v/chapters/115/toc.html  Requirements for paper and electronic records that can be admitted as evidence in federal courts.
• Internal Revenue Code section 6001, http://caselaw.lp.findlaw.com/casecode/uscodes/26/subtitles/f/chapters/61/subchapters/a/parts/i/sections/section_6001.html. Authority for IRS to require taxpayers to keep and provide records.
• Internal Revenue Regulation section 1.6001-1, 26 CFR 1.6001-1, http://a257.g.akamaitech.net/7/257/2422/14mar20010800/edocket.access.gpo.gov/cfr_2002/aprqtr/26cfr1.6001-1.htm Requires taxpayers to keep records "sufficient to establish the amount of gross income, deductions, credits, or other matters required" and "retained so long as the contents thereof may become material in the administration of any internal revenue law."
• Internal Revenue Code section 7602, http://caselaw.lp.findlaw.com/casecode/uscodes/26/subtitles/f/chapters/78/subchapters/a/sections/section_7602.html.  Authority to summon records.

 Internal Revenue Service - Rulings and Directives

• Field Directive on the Use of Estimates from Probability Samples,  Large and Mid-Size Business Division, Director of Field Specialists, (March 14, 2002), www.irs.gov/pub/irs-utl/dir_use_prob_sampling.pdf  Describes requirements for samples developed by taxpayers.
  
• Field Service Advice 200151004, (2001).  A taxpayer could not use a non-statistical stratified sampling method for asset classification where the sample size was too small and sample items were judgmentally selected.
  
• Field Service Advice 200219005 and 200209028, (2002).  Taxpayers can not use statistical sampling to establish the portion of its total meal and entertainment expense that is exempt from the Code Sec. 274(n) 50% deduction limit. Reversed by Revenue Procedure 2004-49.
  
• Form 4564. Information Document Request (IDR).  Used to request data, reconciliations, and explanations of sample and population data.
  
• General Counsel Memorandum 38727, (May 21, 1981).  Discusses how a corporation may properly use a statistical sampling method to determine its basis of stock acquired in a reorganization.
• Internal Revenue Manual - obsolete sections
  
• Internal Revenue Manual section 4.3.13, Computer Assisted Audit Program (CAAP) Handbook, (revised May 3, 1999).  Replaced by IRM 4.47 in August 2002.
• Internal Revenue Manual section 4.10.3.12, Sampling Techniques (revised May 14, 1999).   Replaced by IRM 4.47.3 in August 2002.
• Internal Revenue Manual section 8.10.1.2.4, Statistical Sampling Applications (revised June 3, 1998).
• Internal Revenue Manual section 42(18)(0), Statistical Sampling Examination Program (revised November 4, 1994).
  
• Internal Revenue Manual section 42(18)(4.1).  Establishes rules for determination of the proposed population adjustment where the IRS has taken the sample.
• Internal Revenue Manual section 4.43.1.5.9, Computer Assisted Audit Techniques Programs (revised January 1, 2002).
• Internal Revenue Manual section 4.47.1, Computer Audit Specialist Program (revised August 31, 2002).
• Internal Revenue Manual section 4.47.2, Computer Audit Specialist Technical and Procedural Information (revised August 31, 2002).
• Internal Revenue Manual section 4.47.3, Statistical Sampling Techniques (revised August 31, 2002).

• Revenue Procedure 64-4, 1964-1 C.B. 644.   Describes statistical sampling procedures for income tax audits involving sales of personal property under a revolving credit plan.
• Revenue Procedure 71-21, 1971-2 C.B. 549. If adequate data are available to the taxpayer, statistical sampling is allowed for determining when services are performed with respect to contingent service agreements.
• Revenue Procedure 72-36, 1972-2 C.B.771.  Describes statistical sampling procedures for audits of trading stamps.  Appendix in the print verion includes J. Edwards Deming's "Standards of Probability Sampling for Legal Evidence".
• Revenue Procedure 81-70, 1981-2 C.B. 729.   Describes statistical sampling procedures for determining shareholder's basis in stock of an acquired corporation.  Includes guidelines for nonresponses from shareholders.
• Revenue Procedure 85-51, 1985-2 C.B. 717.   Describes statistical sampling procedures for determining qualification of an employer-provided educational grant program.
• Revenue Procedure 86-19, 1986-1 C.B. 558.   Describes recordkeeping requirements for taxpayers with electronic records.
• Revenue Procedure 91-22, 1991-1 C.B. 526.  Describes procedures for Advance Pricing Agreements (APA).  Section 10.04 discusses record retention requirements.
• Revenue Procedure 91-59, 1991-2 C.B. 841.  Update Rev. Proc. 86-19.  Describes recordkeeping requirements for taxpayers with electronic records.
• Revenue Procedure 97-22, 1997-13 I.R.B. 9.  Describes requirements for electronic and imaged records.
  
• Revenue Procedure 98-25, 1998-1 C.B. 689.   Section 5 describes retention of electronic data.  Section 10.01 explains how taxpayers can apply for a Record Retention Limitation Agreement (RRLA).  Section 10.03 describes the IRS District Director's authority to test the authenticity, readability, completeness, and integrity of a taxpayer's computer records.
• Revenue Procedure 98-31, 1998-1 C.B. 1199.   Section 2.03 mentions IRS seeks comments on statistical sampling for determining minimum effectively connected net investment income of insurance companies.
• Revenue Procedure 99-30, 1999-2 C.B. 221.  Section 2.03 mentions IRS decided to use population data from all available returns rather than statistical sampling for determining minimum effectively connected net investment income of insurance companies.
  
• Revenue Procedure 2000-12, 2000-4  I.R.B.    Section 10.04 discusses use of statistical sampling.in connection with auditing Qualified Intermediaries (QI) for withholding tax on payments to nonresident aliens.
• Revenue Procedure 2000-32, 2000-33 I.R.B. 172. IRS decided to use population data from all available returns rather than statistical sampling for determining minimum effectively connected net investment income of insurance companies.
• Revenue Procedure 2004-29, 2004-29, 2004-20 I.R.B. Permits statistical sampling to be used to substantiate meal and entertainment (M&E) expenses that are excepted from the 50% disallowance rule because of Code Sec. 274(n).  Appendix A describes statistical sampling plan standards including use of upper or lower limit of 95% confidence interval and minimum sample size of 30 per stratum and 100 for all strata.  Appendix B describes sampling documentation standards.
• Revenue Procedure 2004-34, 2004-  I.R.B.   This procedure describes the deferral method of income recognition on contingent service agreements.  Section .03(2)(c) allows the use of "representative sample contracts".  Announcement 2004-48 that accompanied Revenue Procedure 2004-34 said, "Because the deferral method in the proposed revenue procedure was based exclusively on the taxpayer's financial reporting method, the proposed revenue procedure did not provide an independent method for using a statistical or other basis for determining when an advance payment is earned through performance. Section 3.06 of Rev. Proc. 71-21 provided a rule for using a statistical basis, if adequate data are available to the taxpayer, for determining when services are performed with respect to contingent service agreements. Some commentators were concerned that a similar provision was not included in the proposed revenue procedure."
• Revenue Procedure 2007-35, www.irs.gov/pub/irs-drop/rp-07-35.pdf. Guidance for determining when statistical sampling may be used for the purposes of IRC Section 199 qualified production activities. Appendices A, B, and C define the technical requirements for the sampling plan.

• Revenue Ruling 71-20, 1971-1 C.B. 392.  IRS held that punched cards, magnetic tapes, disks, and other machine-sensible data media used for recording, consolidating, and summarizing accounting transactions and records within a taxpayer's automatic data processing system are records within the meaning of section 6001 of the Code and section 1.6001-1 of the regulations and are required to be retained so long as the contents may become material in the administration of any internal revenue law.
  
• Revenue Ruling 81-205, 1981-2 C.B. 225.  Revenue agents may impose penalties for failure to maintain required machine-sensible records.
• Revenue Ruling 2003-43, 2003-21 I.R.B. 935. IRS held employers could not use sampling to validate employee medical expense reimbursements under a subsection 105(b) plan.  IRS held that the payments were taxable income to the employee unless every item submitted by the employee was substantiated.
  
• Revenue Ruling 2003-106, 2003-44 I.R.B. 936.  An employer's travel and expense reimbursement plan using electronic receipts and credits cards may meet the accountable plan requirements of subsections 62(a) and 62(c).

Internal Revenue Service - Training and Publications

• Advanced Statistical Sampling, IRS Training Course 3174, (revised May 1992).
• Basic Statistical Sampling, IRS Training Course 3172, (revised August 1993).
• Computer Audit Specialist (CAS) Digest.
• Statistical Sampling Handbook, Research Division - Statistical Methods Group - Research Document 7391, (November 1988), GPO Superintendent of Documents call number T 22.19/2:St 2/2. General reference on statistical sampling methods and terminology for use in auditing, tax return studies, and program evaluation.

Journal Articles and Other

• Batcher, Mary, "Statistical sampling: A potential win for business taxpayers", 53 Tax Executive 464 (November 2001).
• Federation of Tax Administrators Task Force on EDI Audit and Legal Issues for Tax Administration, Model Recordkeeping and Retention Regulation, (March 1996), www.taxadmin.org/fta/modelreg.pdf
• Felix, William L, Jr., and Robert S. Roussey, "Statistical Inference and the IRS", 159 Journal of Accountancy 38 (June 1985).
• Loebbecke, James K., "Statistical Sampling in Tax Audits", 28 Tax Executive 313 (July 1976).
• Mulrow, Jeri and Eric Falk, "What's the Risk Due to Sampling in Tax Audits and Planning?", 90 Tax Notes 939 (February 12, 2001).
• Press, James J., "Sample-Audit Tax Assessment for Businesses: What's Fair?", 13 Journal of Business & Economic Statistics 357 (July 1995).   Discusses assessment at lower-bound of confidence interval and sample size in tax audits.
• Schiel, Ron, "May Businesses Use Statistical Sampling to Verify Expense Accounts?", 28 The Tax Adviser 408 (July 1997).