IRS wants company's tax return software.

The Eighth Circuit Court has ordered enforcement of the first Internal Revenue Service summons seeking the software a taxpayer used to prepare its consolidated federal income tax return (United States v. Norwest Corporation [no. 96-2792, CA8-June 26, 1997]). The IRS believes that the software -- particularly its underlying "code" -- will provide greater insight into the company's complex computations, such as those used to compute its allocations figures. Norwest, a large bank holding company, licensed Tax Director, a suite of tax preparation programs, from Arthur Andersen & Co.

Responding to the IRS request, Norwest and Andersen went to some lengths to provide the IPS computer with files and software, other than Tax Director, that would allow the IPS to tie the company's tax return to the company's financial data. The IRS was not satisfied and issued a designated summons for preparation programs (a designated summons suspends the statute of limitations). A magistrate ordered enforcement with certain limitations intended to protect Arthur Andersen's proprietary interest in Tax Director. With some modifications, the federal district court affirmed the magistrate's order.

In their appeal, Norwest and Andersen argued that Tax Director was not the proper subject of a summons because the program was merely a tool, akin to a calculator, that contained no information regarding the taxpayer. Circuit judge Arlen C. Beam rejected their argument on the basis that the software's arithmetical processes and ability to organize financial information qualified it as a "record" or "other data" under Internal Revenue Code section 7602. Norwest and Andersen also challenged the summons as failing to meet the relevancy and legitimate purpose standards set forth in United States v. Powell (379 US. 48, 1964).

The court found for the IRS saying the software was relevant as "the final step in translating the company's summary book income into the information reported on the returns."

Observation. A number of companies have been put in the uncomfortable position of having the IRS request tax preparation software that their software licenses preclude them from providing. The court said the Copyright Act does not override the IRS's summons authority; however, the court did not address Norwest's contractual obligations under the license because Arthur Andersen intervened in the enforcement action. With this success in the Eighth Circuit Court, the IRS is sure to expand its efforts to obtain tax preparation software. Companies should be aware the IRS also wants tax planning software, the relevancy of which may be more difficult to establish.