Revision of IRS record retention procedures.
TEI's comments and draft revenue procedure were prepared under the aegis of its IRS Administrative Affairs Committee, whose chair is W. Remi Taylor of Duke Power Co. Robert D. Adams of the Halliburton Company, vice chair of the committee, and Robert Evans of MCI Communications Inc. contributed materially to the development of the proposed revenue procedure. In addition, members of several TEI chapters submitted comments on the procedure that were incorporated into the final product.
On behalf of Tax Executives Institute, I am pleased to enclose a proposed revision of Rev. Proc. 91-59, relating to the basic record retention requirements under section 6001 of the Internal Revenue Code where all or part of a taxpayer's accounting or financial records are maintained within an automatic data processing (ADP) system. The Institute's revision is intended to clarify a number of technical and procedural issues that have arisen concerning the revenue procedure, to safeguard the Internal Revenue Service's authority regarding ADP (or machine-sensible) records, and to assuage taxpayers concerns about the heavy administrative and compliance burdens engendered by Rev. Proc. 91-59 (either on its face or as interpreted by taxpayers or IRS Computer Audit Specialists). This letter provides background on the Institute's record retention project and summarizes our principal areas of interest.
In October 1991, the Internal Revenue Service issued Rev. Proc. 91-59, relating to the basic record retention requirements where all or part of a taxpayer's accounting or financial records are maintained within an automatic data processing (ADP) system. The 1991 procedure superseded Rev. Proc. 86-19, and was intended not only to clarify provisions of the 1986 rules but also to keep pace with ADP developments. In particular, Rev. Proc. 91-59 was intended to address the application of section 6001 of the Internal Revenue Code and the pertinent regulations to electronic data interchange (EDI) technology.
Tax Executives Institute has long been involved in the development and refinement of the IRS's record retention rules in respect of machine-sensible records. Our representatives met with IRS officials during the development of the 1986 procedure, and in 1990 and 1991 held similar meetings on how a revised procedure - which became Rev. Proc. 91-59 - should address not only issues such as EDI and the application of section 6001 to records created on personal (micro) computers, but more fundamental questions such as the availability of record retention agreements between taxpayers and the IRS, the requirements that taxpayers provide computer resources to the IRS to process machine-sensible records, and whether a record evaluation by a CAS constituted an examination for purposes of section 7605(b) of the Internal Revenue Code.
Our involvement in the IRS's record retention policies and procedures has continued since the issuance of Rev. Proc. 91-59. Shortly after the issuance of the procedure, Marvin Burton of the IRS's Computer Audit Branch - who has been described as the architect of the new procedure - briefed the Institute's 1991 Annual Conference on the tenor, tone, and scope of Rev. Proc. 91-59. In his presentation (and in a number of subsequent meetings), Mr. Burton stressed one thing above all others (at least from the taxpayer's perspective): Rev. Proc. 91-59 was intended not to impose a series of arbitrary requirements but rather to empower taxpayers to decide which records to retain.
Regrettably, the words of revenue procedure did not seem to mesh well with the philosophy espoused by Mr. Burton and other IRS officials. Rev. Proc. 91-59 at best muddied the waters and at worst imposed heavy and unrealistic burdens on taxpayers. Fundamentally, the procedure struck many if not most taxpayers as overbroad. Instead of clarifying that taxpayers could exercise judgment in deciding which records to retain (and in which form), the procedure was interpreted as requiring the retention of all records, as imposing requirements that retained records be subjected to unduly rigorous testing standards, and as threatening taxpayers with penalties should certain (unspecified) records not be retained or not be processible at the time of audit. In addition, the revenue procedure was interpreted by IRS field personnel as discouraging (if not proscribing) the use of record retention agreements between taxpayers and their District Directors - agreements that to our mind's eye bring certainty and predictability to the process (attributes that large taxpayers in particular find helpful). Finally, the revenue procedure seemed to drive a wedge between taxpayers and their Computer Audit Specialists: rather than encouraging cooperative efforts between taxpayers and the IRS to satisfy the IRS's legitimate interests (access to necessary records at the time of examination), the revenue procedure heightened the tension between taxpayers and the IRS and the level of contentiousness.
TEI Revision Project
In an effort to establish a better balance of taxpayer and IRS interests, TEI more than a year ago undertook to catalog taxpayer concerns with Rev. Proc. 91-59, to identify possible solutions, and to convince the IRS that the revenue procedure should be revised. The Institute's efforts have included presentations by IRS personnel at TEI educational programs, the participation of TEI members and staff in IRS training programs, and the solicitation and synthesis of comments on the revenue procedure from Institute members.
These efforts reached their culmination in early April and late May when TEI sat down for five days with IRS representatives to redraft Rev. Proc. 91-59. (The IRS representatives were Mr. Burton and Jerry Davis, also of the Computer Audit Branch.) The product of the sessions was a draft revision of the revenue procedure. Although the draft reflects the substantial comments of the IRS representatives - and attempts to strike a balance on a number of issues - we do not presume that it reflects the official views of the IRS. We do submit, however, that it represents a tremendous improvement over Rev. Proc. 91-59 and can form the basis for a new revenue procedure that more properly balances the needs of taxpayers and the IRS. We encourage the IRS to embrace the revised procedure as a vehicle for improving the 1991 procedure.
Overview of Revised Procedure
In submitting the draft revenue procedure for IRS review, TEI seeks to advance several goals:
* eliminating the seemingly rigid and unforgiving requirements of Rev. Proc. 91-59.
* providing taxpayers with specific guidance on what their obligations are (while recognizing that the procedure must have a certain "one size fits all" quality - since it applies to all taxpayers and all types of computer/data processing systems).
* empowering taxpayers to decide what records to keep and how to respond to changes in their data processing systems (as well as to lost or damaged records).
* setting forth rules for how taxpayers can secure IRS assistance in fulfilling their record retention obligations under section 6001 (through either record retention agreements or record evaluations).
Let there be no mistake: there is no uniformity of views among TEI members on what should be included in, or excluded from, the new revenue procedure. Some members would prefer more detail, whereas others want the flexibility that comes from more general terms and examples. On balance, we have endeavored to walk the line between too much detail (which can be constrictive if a particular taxpayer's facts do not match those in the procedure) and too little (which can leave taxpayers - and IRS field personnel - guessing).
The revised procedure contains three introductory sections: the first sets forth the revenue procedure's purpose; the second, certain background information; and the third, the overall scope of the rules, including certain definitions. We have consolidated information from several sections of Rev. Proc. 91-59 in order to clearly say what is and what is not covered by the procedure. Thus, proposed section 3 not only sets forth general rules on scope, but has specific sections on the types of taxpayers that are covered (including special classes of taxpayers) and a discussion of the general types of ADP systems and records that are within the scope of the procedure.
Sections 4 and 5 of the revised procedure attempt to define the overall relationship and responsibilities of taxpayers and the District Director concerning record retention issues. Section 4 embraces the principle of taxpayer empowerment. It makes it clear that taxpayers are responsible for keeping the machine-sensible records necessary to audit their tax returns, but clarifies that redundant or duplicate records need not be retained. In addition, the procedure acknowledges that a taxpayer may contract with third parties (including the acquirer of a disposed subsidiary) concerning record retention but confirms that any such contract will not relieve the taxpayer of its ultimate responsibility under section 6001. It also acknowledges that taxpayers may request assistance from the District Director (or CAS) in determining which records to retain, and that such assistance should not be unreasonably denied. The specifics of the District Director's authority are covered in proposed section 5. In this section, we discuss the effect of District Director record retention agreements, record evaluations, and periodic tests to establish the taxpayer's compliance with the revenue procedure.
A primary purpose of sections 4 and 5 is to allay taxpayer concerns that the revenue procedure will be used only as a weapon by the IRS, not also as a taxpayer shield; consistent with recent IRS quality initiatives, it is intended to lay the groundwork for cooperative efforts. In other words, while recognizing that taxpayers bear ultimate responsibility for compliance with section 6001, the procedure acknowledges the District Director should assist taxpayers in minimizing their compliance burden. By confirming the taxpayer's ability to seek and secure record retention limitation agreements, to secure record evaluations, to receive an explanation from the IRS where such agreements or evaluations are denied, and indeed, to "appeal" within the IRS a decision by the CAS or District Director not to exercise their authority to enter into such an agreement or make such an evaluation, the revenue procedure will go a long way to restoring taxpayer confidence.
Section 6 defines what is meant by "machine-sensible records" that are "capable of being processed" by the IRS. It also contains specific guidance on the records that taxpayers must retain (and need not retain) in respect of EDI records. Section 7 describes the systems documentation that taxpayers must retain, and section 8 discusses the maintenance (and testing) requirements that must be followed to ensure compliance. One of the purposes of revised section 8 is to eliminate the inference in Rev. Proc. 91-59 that taxpayers must necessarily abide by the rigorous standards established by the National Archives and Record Administration (NARA). Although TEI agrees that reference to a specific set of standards is useful, we believe the procedure should explicitly confirm that the NARA standards are not the only means of satisfying section 6001.
Section 9 deals with the highly sensitive issue of what computer resources taxpayers must provide to the IRS in connection with an audit. Although many, if not most, taxpayers are willing to facilitate the IRS's examination of their tax returns through the provision of computer resources, the Institute does not share the IRS's expansive view of its authority under United States v. Davey, 543 F.2d 996 (2d Cir. 1976). Indeed, we read the court's decision in Davey as circumscribing the IRS's authority to transfer the cost and burden of providing computer resources to the taxpayer in all instances.
We believe the key to the computer resources issue is balance. Thus, our proposed section 9 states that the taxpayer shall provide the IRS with "the computer resources * * * reasonably necessary to process the retained machine-sensible records." In addition, the section attempts to illustrate the range of options available to the taxpayer and District Director in facilitating the audit.
Section 10 focuses on what happens if a taxpayer's records become incapable of being processed, either because the records are lost or damaged or because the taxpayer's ADP hardware or software system changes. Again, a key point of the section is the latitude the taxpayers and the District Director have to work together to deal with the situation. The ultimate responsibility for compliance will continue to lie with the taxpayer, but the revised procedure confirms that the same "solution" need not be required in all situations. For example, upon changing its software or hardware system, a taxpayer will not be automatically required to incur the cost and burden of converting its old records to the new system.
Section 11 discusses the effect of the procedure on hardcopy recordkeeping requirements, and specifically addresses whether hardcopy records need be created in respect of EDI transactions. Section 12 covers the District Director's authority to issue a Notice of Inadequate Records, as well as the potential penalties that a taxpayer may be subjected to for failing to comply with the revenue procedure. Although we agree that taxpayers should be placed clearly on notice concerning the possible consequences of noncompliance, we believe Rev. Proc. 91-59 overemphasized the role of penalties in the record retention area. Thus, we have tempered the discussion of penalties.
Sections 13 and 14 discuss the effect of the revised procedure on Rev. Proc. 91-59 and its predecessors and the effective date of the new rules. Finally, section 15 sets forth the address to which questions about the record retention rules should be directed.
As previously stated, TEI considers the revised procedure to be the product of a collaborative effort, and we greatly appreciate the assistance received from Marvin Burton and Jerry Davis as we refined the Institute's own views on the Code's record retention requirements. We have endeavored to be sensitive to the IRS's requirements and have incorporated their comments and suggestions whenever possible. In summary, then, we believe the draft revenue procedure markedly improves upon Rev. Proc. 91-59. By advancing the concept of taxpayer empowerment, by emphasizing the flexibility that taxpayers have to work with the IRS in developing their retention policies and practices (including the use of record evaluation and District Director agreements), and by addressing the subject of taxpayer-provided computer resources, the revised procedure establishes a framework that properly balances the record retention needs of both taxpayers and the IRS.
We sincerely hope that the draft can form the basis for a new revenue procedure. In this regard, we urge the IRS not only to circulate the procedure for comment within the IRS, but to consider releasing the draft to taxpayers and other organizations as a discussion draft." There is precedent for such an approach: in early 1990, the IRS released for public comment the New York State Bar Association's draft "simplified" partnership regulations under section 752. (See 90 TNT 26-14 (Feb. 1, 1990).) We have discussed such an approach with Messrs. Burton and Davis, and they responded that the idea holds promise as a way of advancing the debate.
Last but not least, we urge the IRS to expeditiously issue guidance on the whole question of digital imaging. We readily acknowledge that digital imaging is not within the scope of the revised procedure, but nevertheless wish to emphasize the need to forthrightly address the issue. An increasing number of our members are finding their ability to use new and emerging technology inhibited by the lack of guidance from the IRS. Consequently, we urge the IRS to develop a separate revenue procedure on digital imaging technology and systems - just as it has with respect to microfilm and microfiche. We would be pleased to contribute to any such project.
The Institute is eager to meet with you or other IRS representatives to discuss the enclosed draft record retention procedure. If you should have any questions about the draft or about the issues discussed in this letter, please do not hesitate to call either W. Remi Taylor of Duke Power Company, the chair of the Institute's IRS Administrative Affairs Committee, at (704) 382-8174, or Robert D. Adams of Halliburton Company, vice-chair of the committee, at (214) 978-2695. Alternatively, your call could be directed to Timothy J. McCormally of the Institute's professional tax staff at (202) 638-5601
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|Date:||Jul 1, 1993|
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