The Internal Revenue Manual 4.47.3 discusses the answer to the tedious problem of an IRS examiner being required to inspect every entry in an expense account during an audit. Instead of an IRS Agent having to look at every expense entry in a REPAIRS account, for example; he could closely inspect a small portion of the entries and use the result to calculate an adjustment based upon a percentage or a formula. IRS has statistical sampling experts and computers which can be utilized to arrive at a computation of an adjustment. Sampling only works if the agent selects items at RANDOM. The problem of sampling is that it is based upon an ASSUMPTION and therefore can be wrong. If a tax preparer encounters sampling during an IRS audit he should make sure the sampling was random. In some cases it may be wise to extend the sampling by having the taxpayer present cancelled checks and receipts for a larger portion of the grand total claimed in the expense account or even have ALL cancelled checks and receipts inspected for entries made to this account. If the expense account is for REPAIRS some or all of the proposed adjustments may be subject to a depreciation allowance. See Rev. Proc. 2011-42.
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Stratified Sampling
Dyne, good advice, but I believe they are allowed to use "stratified" sampling, which differs from "random" sampling because it allows a disproportionate chance of selection to be weighted toward high end dollar amounts. For example, from a population of several amounts charged to repairs, the selection might be 1 of 2 for dollar amounts over $1000 and 1 of 12 for dollar amounts under $1000. If a total random approach were used, the selection might be 1 of 10 without respect to dollar amounts whatsoever.
You mentioned a possible audit conversion of repairs to depreciable costs. I believe there are audit guidelines which will cause a repair of a certain percentage to be capitalized even if the cost is a pure repair and not an improvement. How many readers have encountered this from an auditor? I haven't, but I believe it is strictly because the auditors have not wanted to spend a lot of useless time going through equipment schedules.
An example of an above-described situation. Cost of a building is $150,000. As a result of old and faulty wiring the original HVAC has to be replaced, along with wall relocation, and other extensive repairs. $60,000 is spent, and NONE of it is for new equipment or building or improvements which did not exist to begin with. The auditors' guideline is 35% so he disallows the $60,000 as an expense and requires it to be depreciated over 40 years. Is this type of audit adjustment still commonplace??
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