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IRS record retention rules and the computer age.

Pursuant to Treasury regulations under Sec. 6001, taxpayers must retain books and records as long as the contents may become material to any matter under IRS jurisdiction. In today's technologically advanced business environment, questions arise over what records must be retained when a taxpayer is using technology such as automatic data processing lADP) systems or electronic data interchange (EDI).

It is important that taxpayers keep records to support income, deductions and credits, as shown on their filed returns. The Service may assess additional tax, and even civil and criminal penalties under Secs. 6662 and 7203, for failure to retain appropriate records. Clearly, records must be kept as long as the statute of limitations remains open for a particular year, however, tax determinations dependent on the basis of property and items such as NOL carrybacks and carryovers significantly increase required retention periods.

The IRS's principal guidance on machine-sensible records is found in Rev. Proc. 91-59. Generally, Rev. Proc. 91-59 applies to taxpayers with assets of $10 million or more. It also applies to taxpayers with assets of less than $10 million if(1) the books and records are only available in machine-sensible format, (2) machine-sensible records were used for complex computations (e.g., LIFO or Sec.263A) or (3) the taxpayer is notified by the Service that machine-sensible records must be retained.

Under Rev. Proc. 91-59, documentation of an accounting system, including all subsystems and files that feed into the system, must be retained and made available to the IRS on request. This includes punched cards, magnetic tapes, disks and other machine-sensible data used for recording, consolidating and summarizing accounting transactions and records within a taxpayer's ADP system. These records must be able to be reconciled with the taxpayer's books and tax return.

In addition, Rev. Proc. 91-59 sets forth specific procedures that the taxpayer must perform to insure the integrity of the system and the accessibility of the records. Also, the taxpayer must provide the Service with computer resources (e.g., terminal access, computer time and personnel) necessary to process the retained information; failure to do so will be considered a failure to maintain books and records. A taxpayer using an outside processing service or a value-added network is not relieved of Rev. Proc. 91-59 requirements.

Retention of ADP records or files does not eliminate the need to retain hardcopy documents. Conversely, retention of hard copies does not obviate the need to keep electronic records.

A taxpayer is not required to create hardcopy documents for purposes of record retention if no such document is produced in the ordinary course of business, unless requested by the Service. If hardcopy records exist and are transferred to microfiche or micro film format in accordance with IRS requirements, the hardcopy records may be destroyed.

In limited instances, taxpayers may enter into an agreement with the district director to modify or waive all or any of the specific requirements in Rev. Proc. 91-59. Before making such an agreement, the district director will perform an evaluation of the taxpayer's system.

Rev. Proc. 91-59 is the Service's first attempt to address EDI, a relatively new but increasingly popular medium of information exchange. EDI allows movement of information more quickly and accurately by direct computer-to-computer exchange of information, and allows for many types of electronic business transactions without generation of the traditional paper documents. For example, a retailer may conduct purchasing transactions electronically with its vendors, eliminating the traditional paper documents (such as purchase orders, invoices and shipping notices).

In the EDI environment, the information that otherwise would be contained in traditional paper documents is generally available in electronic format. This electronic data may or may not be in the traditional form of paper documents, since it may be more practical to disassemble the original transmissions and reorganize the data to meet the needs of the user of such information.

In keeping with the IRS's intent not to create additional recordkeeping, what is required to be retained with respect to an EDI system? It is sufficient to retain the data from EDI transactions in electronic format, provided the extent of the detail is equivalent to the level of detail contained in an acceptable paper record. For example, an electronic invoice must contain identification of the vendor by name, invoice date, product description, quantity purchased, price, etc. This information may be captured at any level within the system, provided the audit trail, authenticity and integrity of the information are established.

In addition, Rev. Proc. 91-59 provides an exception under. which hardcopy records generated at the time of a transaction (e.g., credit card receipts) may be destroyed, if all such information subsequently is received by the taxpayer in an EDI transaction and is retained in electronic format in accordance with the revenue procedure.

In many situations, taxpayers have not updated their record retention policies to keep pace with their computer systems. In light of the rules involved, taxpayers should review their current policies.

From Jeffrey J. Tailyen, CPA, Washington, D.C.
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Author:Tallyen, Jeffrey J.
Publication:The Tax Adviser
Date:Jul 1, 1992
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