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Electronic storage of records.

Editor's note: Mr. Ely chairs the AICPA Tax Division's Tax Practice & Procedures Committee. Ms. Everidge, Mr. Johnson, Mr. Olson and Mr. Lerman are members of the committee.

Electronic Storage of Records

In Rev. Proc. 98-25, the IRS released requirements it considers essential for taxpayers who maintain tax records electronically. These requirements, which modify and supersede those in Rev. Proc. 91-59, are effective for machine-sensible records for tax years after 1997. Record retention issues are growing in importance in light of the new "enterprise-wide" accounting systems (e.g., SAP, Oracle, etc.) that many are installing. Failure to comply with these requirements could result in the imposition of penalties.


Sec. 6001 requires every person liable for tax to keep adequate books and records. Generally, all Sec. 6001 requirements that apply to hardcopy books and records apply as well to machine-sensible books and records (i.e., data in an electronic format intended for use by a computer) and records maintained within an automatic data processing (ADP) system. An ADP system includes (but is not limited to) a mainfi2me, stand-alone or networked microcomputer system, data base management system, and a system that uses or incorporates tectronic data interchange or an electronic storage system. This revenue procedure does not relieve taxpayers of their responsibility to retain hardcopy records that are created or received in the ordinary course of business as required by existing law and regulations. (Rev. Proc. 97-22 prescribes specific rules for electronic storage systems (e.g., optical imaging).)

Who Must Comply

1. Taxpayers with assets of $10 million or more at the end of their tax year.

2. Taxpayers with assets of less than $10 million at the end of their tax year if:

* All or part of the information required by Sec. 6001 is not in the taxpayer's hardcopy books and records, but is available in machine-sensible records;

* Machine-sensible records are used for computations that cannot be reasonably verified or recomputed without using a computer (e.g., LIFO inventories); or

* The taxpayer is notified by the district director that machine-sensible records must be retained to meet Sec. 6001 requirements.

3. A controlled foreign corporation, a domestic corporation that is 25% foreign-owned or a foreign corporation engaged in a trade or business in the U.S. at any time during a tax year that maintains machine-sensible records within an ADP system.

4. Insurance companies that maintain machine-sensible records within an ADP system to determine losses incurred under Sec. 832(b)(5).

Basic Requirements

A taxpayer must retain machine-sensible records for as long as the contents may become material under Regs. Sec. 1.6001-1(e). At a minimum, this materiality continues until the expiration of the period of limitations for assessment (including extensions) for each tax year. In certain situations, some records (i.e., fixed assets, losses under Sec. 832(b)(5) and LIFO inventories) should be kept longer.

Machine-sensible records must provide sufficient information to support and verify entries made on a taxpayer's return and to determine the correct tax liability. The machine-sensible records must reconcile with the taxpayer's books and its return in order to meet this requirement (i.e., provide an audit trail).

A taxpayer must ensure that machine-sensible records contain sufficient transaction-level detail, so that the information and the source documents underlying these records can be identified, and make available to the Service on request all machine-sensible records required to be retained and capable of processing. As a general rule, however, a taxpayer is not required to create any machine-sensible record other than those created in the ordinary course of its business or to establish return entries.

Taxpayers that use a third party (such as a service bureau, time-sharing service, value-added network or other third-party service) to provide services with respect to machine-sensible records are not relieved of these record-keeping obligations and responsibilities.


A taxpayer must maintain and make available to the IRS on request documentation of the business processes that create, modify and maintain its records; that satisfy the requirements to support and verify entries made on the taxpayer's return and determine the correct tax liability; and that verify the authenticity and integrity of the taxpayer's records.

This documentation must be sufficiently detailed to identify: the functions being performed as they relate to the flow of data through a system; the internal controls used to ensure accurate and reliable processing; the internal controls used to prevent the unauthorized addition, alteration or deletion of retained records; and the charts of accounts and detailed account descriptions.

Other Issues

At the time of an examination, a taxpayer must provide the IRS with the resources (i.e., hardware, software, terminal access, computer time and personnel) deemed necessary for the Service's access and use of the machine-sensible records. In addition, an ADP system must not be subject to an agreement that would restrict the Service's use of the system. Further, if a taxpayer replaces its original ADP system with a new system that cannot process the machine-sensible records created and maintained by the original system, the taxpayer must notify the IRS and propose a plan to assure that the original records can be processed.

Record Retention Agreements

A taxpayer who maintains machine-sensible records may request to enter into an Record Retention Limitation Agreement (RKLA) with the district director. This agreement allows the taxpayer and the IRS to agree on the records to be maintained. It is up to the taxpayer to identify those records it proposes not to maintain. If a taxpayer requests an RRLA, the Service may conduct a "records evaluation," to review the taxpayer's record retention practices. Because the alternative to having an RRLA is to keep all machine-sensible records, this agreement may be critical to many taxpayers.
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Author:Everidge, Kathryn L.
Publication:The Tax Adviser
Date:Jul 1, 1998
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