SB/SE Division Issues Memo to Agents on Asking for Electronic Accounting Records in an Examination

The IRS Small Business/Self-Employed Division issued guidance to examiners (IRS SB/SE Memorandum SBSE-04-0911-086, 9/1/11) regarding the IRS’s program requesting electronic accounting software records and, at the same time, updated the Frequently Asked Questions page on the IRS website regarding such records.

The memorandum indicates that “if the taxpayer uses one of the accounting software products the IRS can read, examiners should generally request a copy of the taxpayer’s original accounting software backup file” though it goes on to note that if the audit is a limited scope audit of one expense item on the return such a request may not be necessary.

The memo informs examiners that even though the file may contain data from multiple years, they should not generally examine transactions outside the period of examination except for limited access to transactions just before and after the period of the exam if relevant to the period.  As well, the agent is allowed to examine any transactional data created or changed during the year under examination—so if the client makes changes to an earlier year, the agent would be allowed to look at those transactions.  Similarly, adjusting entries are often made by the outside accountant early in the following year, so such entries would also be items available for examination (since they would represent data created during the period under examination).

The memo gives some insight into the IRS’s view of what may be valid assertions of privileged or restricted information that a taxpayer may argue makes it inappropriate for the taxpayer to turn over the information.  The memo takes the position that, generally, customer lists are not privileged information.  However, if the taxpayer takes the position that a statute prevents compliance (such as HIPAA information in a file of a medical practice) the agent should consult the local Counsel office.

As well, potential practitioner privilege is also discussed in the memo, noting that if the practitioner asserts either attorney/client privilege or IRC §7525 tax preparer privilege the agent should consult with the local Counsel’s office.

The FAQ page contains the (likely intentionally) chilling caution that if a practitioner fails to voluntarily turn over such records that the “representative could be in violation of Treasury Department Circular 230.”  However, practitioners should note that the provision the IRS cites also makes clear that a representative can refuse such a request if “practitioner believes in good faith and on reasonable grounds that the records or information are privileged.”

The frequently asked questions page, in Q&A 13, indicates the conditions under which a taxpayer may condense data files.  The IRS holds that a condensed file will not be acceptable for the year under examination, but a taxpayer may exclude from what is provided prior year backups that the taxpayer had condensed, but only if those backups do not include any transactions that were created or changed in the year under audit.  Reports have indicated that the IRS generally will not allow such condensing to occur once the IDR request has been made.

In IRS Headliner Volume 303 the IRS had previously outlined what it sees as its authority to demand this information.  That document noted “the legal authority for requesting taxpayer’s electronic accounting software files is based on IRC Section 6001, Regulation 1.6001-1(a) and -1(e), Revenue Ruling 71-20 and Revenue Procedure 98-25. Proc. 98-25 does not prevent or exempt a taxpayer from providing electronic records, if such records exist.”

Reports from practitioners around the country indicate the IRS has, in some cases, begun to take the actions noted in the memorandum in examinations, looking for Intuit Quickbooks data files in particular.

Practitioners will need to consider their responsibilities to clients when faced with requests for such data.  The memo does make clear that an agent can consider accepting something other than the data file, but also indicates a preference for the file.  Certainly a practitioner should consider offering alternative

As well, practitioners do need to insure that providing such data does not violate various statutes limiting dissemination of information that might be in the file of a nontax nature, which would generally involve having the client seek outside counsel on the interaction of such statutes (federal or state) with the IRS’s authority.  If it appears such disclosure would violate another statute, legal counsel will likely need to get involved and the agent will similarly need to bring in the local Counsel’s office.

Practitioners also should discuss with clients the issue, including potential implications of information that would be provided to the IRS electronically.  If clients wish to limit the data provided, consideration should be given to developing proper procedures to regularly condense files in a form that the IRS would find acceptable.  As well, to limit the exposure of prior year issues, having the outside accountant do significant work prior to year end each year to find adjustments and make them would insure such adjustments don’t end up being subject to IRS inquiry both in an exam of the year affected by the adjustment and an exam of the following year.

Advertisement