Can a taxpayer void a six-year use-tax audit and challenge a one-year sample period used to project the assessment, and how does a taxpayer request relief from an assessment based on financial hardship?

Plain-English summary

A Virginia general contractor was audited by the Department of Taxation for consumer use tax on purchases it made exempt of sales tax. The taxpayer appealed the resulting assessment on two grounds. First, it argued the audit period itself should be voided because the audit report and Notice of Assessment covered June 2012 through December 2018, while the letter the Department sent when the audit began only described a review period of June 1, 2012 through May 31, 2018. Second, it argued that the one-year sample period the auditor used to calculate the assessment (January through December 2016) was not representative of the full six-year audit period, and asked the Department to instead review documentation for every month in the audit.

On the audit period, the Tax Commissioner sided with the Department. Virginia Code § 58.1-634 normally limits assessments to a three-year look-back, but allows the Department to go back six years when a taxpayer failed to file a required return. Because the contractor had never registered for or filed consumer use tax returns, and the initial three-year review turned up use-tax liability, the Department was entitled to extend the audit to a full six years. Extending the period forward to include the more recent months (June through December 2018) to bring the audit up to date was found not prohibited by statute, so there was no error.

On the sample period, the Tax Commissioner also sided with the Department. Sampling is described as a widely used, legitimate audit technique for cases where a full transaction-by-transaction audit would not be practical for either the auditor or the taxpayer: an error factor is calculated from a representative period and then extrapolated across the whole audit period. Here, the auditor picked calendar year 2016 because it was the closest to the taxpayer's average year for gross receipts, based on the taxpayer's own trial balances, and the taxpayer was told at the start of the audit that a one-year sample would be used this way. Because the taxpayer did not prove the sampling methodology was flawed or unrepresentative, the Tax Commissioner found no basis to invalidate the sample or to require a review of every month in the audit period.

Separately, the taxpayer mentioned during a call with a Department analyst that paying the full assessment would cause financial hardship. The ruling does not resolve this as a contested issue -- instead, it explains the process for seeking relief: the taxpayer may request an offer in compromise based on doubtful collectability by submitting evidence of financial hardship along with the OIC - Fee and OIC B-3 forms to the Tax Commissioner's office within 60 days of the letter. If the forms are not returned in that window, the Department will presume the taxpayer does not intend to pursue that route.

What this means for you

If you are appealing an audit period extension

If the Department extends your use-tax audit from three years to six years, check whether you were registered and filed the required returns for the original three-year period. Under Va. Code § 58.1-634, a six-year look-back is allowed where the taxpayer failed to file a return (or in cases of fraud), even if the audit-opening letter described a shorter window. Simply pointing to a mismatch between the initial engagement letter and the final assessment period is not, by itself, enough to void the audit.

If you are challenging a sample-based assessment

If your assessment was calculated using a sample period extrapolated across a longer audit period, it is not enough to simply assert the sample is unrepresentative -- you need evidence that the sampling methodology itself was flawed (for example, that the sample period was not comparable to the rest of the audit period). If you believe you cannot pay an assessment in full, ask about an offer in compromise based on doubtful collectability, which requires submitting the OIC forms and financial-hardship evidence within the Department's specified deadline.

Common questions

Q: Can I get a use-tax audit voided because the audit's final assessment period is longer than what was described in the opening letter?
A: Not on that basis alone. In this ruling, the Tax Commissioner found no error where the assessment period (June 2012-December 2018) extended beyond the originally stated review window (June 2012-May 2018), because the extension was authorized under Va. Code § 58.1-634 and merely brought the audit up to date.

Q: When can Virginia go back more than three years in a sales/use tax audit?
A: Va. Code § 58.1-634 generally limits assessments to three years from when the tax became due, but allows a six-year look-back (or an unlimited look-back for fraud) where the taxpayer failed to file a return it was required to file -- as was the case for this contractor's consumer use tax.

Q: How do I challenge an auditor's sample period as unrepresentative?
A: You must show the sampling methodology was actually flawed or that the sample period does not represent the broader audit period -- for example, evidence that the sample year was atypical. Simply disagreeing with the result, without such proof, was not enough in this case.

Q: What do I do if I cannot afford to pay a Virginia tax assessment in full?
A: You may request an offer in compromise based on doubtful collectability. You must submit evidence of financial hardship along with the OIC - Fee and OIC B-3 forms to the Tax Commissioner's office; under this ruling's facts, the Department gave the taxpayer 60 days to return the forms before presuming no offer would be submitted.

Citations and references

• Va. Code § 58.1-1821 (basis for the taxpayer's application/appeal to the Tax Commissioner)
• Va. Code § 58.1-634 (three-year general limitation period for sales and use tax assessments, extended to six years where a required return was not filed, or without limit for fraud)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 20-151

Original ruling text

September 1, 2020

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear *:

This is in response to your letter submitted on behalf of * (the “Taxpayer”), in which you seek correction of the retail sales and use tax assessment issued for the period June 2012 through December 2018. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer operates as a general contractor. The Department’s auditor assessed consumer use tax on purchases made exempt of the sales tax during the audit period. The Taxpayer maintains that the audit period reflected in the audit includes months that were not identified at the onset of the performance of the audit. The Taxpayer requests that the audit be voided. The Taxpayer also contends the sample period used to calculate the audit assessment is not representative of the entire audit period and requests that the assessment be recalculated based upon a review of all the documentation provided for the entire audit period.

DETERMINATION

Audit Period

Virginia Code § 58.1-634 provides that:

The taxes imposed by this chapter shall be assessed within three years from the date on which such taxes became due and payable. In the case of a false or fraudulent return with intent to evade payment of the taxes imposed by this chapter, or a failure to file a return, the taxes may be assessed, or a proceeding in court for the collection of such taxes may be begun without assessment, at any time within six years from such date. The Tax Commissioner shall not examine any person's records beyond the three-year period of limitations unless he has reasonable evidence of fraud, or reasonable cause to believe that such person was required by law to file a return and failed to do so.

The Taxpayer provides a letter issued by the Department’s audit staff that informed the Taxpayer of the pending audit review. The letter states that the Department would review the Taxpayer’s records for the period June 1, 2012 through May 31, 2018. The audit report and the Notice of Assessment issued to the Taxpayer at the conclusion of the audit state that the audit period is June 2012 through December 2018.

It is my understanding that the Taxpayer was not registered for the consumer use tax and no returns had been filed. Because use tax liability was found in the initial three-year period reviewed, the audit period was extended to include an additional three years. In accordance with Virginia Code § 58.1-634, an audit period of six years is proper in this instance. The extension of the audit period to include more recent periods (the months June 2018 through December 2018) and bring it up to date is not prohibited by statute. I find no error in this instance.

Sample

Sampling is an audit technique of significant value that is widely used in both the public and private sectors for all types of audits where a detailed audit would not prove beneficial either to the auditor or the client. When sampling techniques are understood and properly applied, the final result should be within a narrow percentage range of the actual amount that would be determined by a detailed audit. The purpose of the audit sample is to determine a factor for errors within a representative selected period. Once the error factor is determined, the factor is extrapolated over the entire audit period. The purpose of the projection is to account for likely similar transactions on which Virginia tax has not been paid.

The Department conducted an audit of the Taxpayer using the sample period of January 2016 through December 2016. The sample period was chosen by the audit staff because it was the closest to the average year for gross receipts based on the Taxpayer’s trial balances. The documentation provided to the Taxpayer at the start of the audit indicated that a one-year sample would be used, and any transactions found during the review without proper taxation would be extrapolated over the other years in the audit period based on gross sales.

After reviewing the audit report and the information presented, I find that the auditor’s use of the one-year sample period was proper. Although the Taxpayer contends that the audit sample is not representative of the entire audit period, the Taxpayer has not proven that the sampling methodology is flawed or unrepresentative of the audit period. Therefore, I find no basis to invalidate the sample and the extrapolation. I further find no basis to review records from all of the months within the audit period. Accordingly, the sampling methodology was properly applied.

Financial Hardship

During a conference call with the Department’s analyst, the Taxpayer indicated that paying the full amount of the assessment will cause a financial burden. As such, the Taxpayer may wish to request an offer in compromise based on doubtful collectability. The Taxpayer must present evidence of doubtful collectability to support a claim of financial hardship.

If the Taxpayer wishes to pursue a settlement based on doubtful collectability, please complete and return the enclosed OIC - Fee and OIC B - 3 forms to: Tax Commissioner, Virginia Department of Taxation, Post Office Box 2475, Richmond, Virginia 23218-2475. These forms will allow the Department to review and analyze the Taxpayer’s financial situation. Upon completion of the Department’s review, a response will be issued based upon the information provided. If the Department does not receive the completed forms within 60 days of the date of this letter, it will be presumed that the Taxpayer will not submit an offer in compromise based upon doubtful collectability.

The Code of Virginia sections cited, along with other reference documents, are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site. If you have any questions concerning payment of the assessments, you may contact * at . If you have questions about this response, you may contact in the Department’s Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2104P