IRS Audits of Electronic Records
Margaret Amsden
Co-authored by: Bryan Powrozek
Internal Revenue Service regulations require that businesses maintain sufficient records to support the income and deductions reported on their tax returns. These records traditionally consisted of countless binders and folders filled with paper copies of schedules and reports. However, as the use of computers has became more common, the number of paper records has decreased. It is now estimated that more than 90 percent of all business records are generated and maintained electronically. Of these records, less than a third are ever printed.
This change in recordkeeping has caused the IRS to shift the focus of its audits from a review of printed records to a review of electronic records, and as a result, businesses should familiarize themselves with the specifics of how the IRS will audit these electronic records.
Time Period
The IRS will typically request fourteen months of electronic data. The twelve months of the year under review as well as the month immediately preceding and following that year. If additional information is provided to the IRS, inspection of the data is limited to this fourteen month timeframe. If the scope of the audit needs to be increased, the IRS will notify the taxpayer of this change in scope.
Format of the Data to be Provided
The IRS is able to accept data from most major accounting software as well as Microsoft Access and Excel. If possible, the taxpayer should provide a back-up version of the data from their accounting software. In the event a backup is not provided, care should be taken not to alter or reconstruct the data being sent to the IRS.
Know Your Accounting Software
Before providing a back-up of the data to the IRS, it is important for taxpayers to understand the capabilities of their accounting software. For example, QuickBooksTM provides the option of creating a period copy which retains the details of transactions within the period but condenses the information prior to that period. This may be an acceptable alternative to providing a complete backup with all the company’s data.
Use of the Data
The data provided to the IRS will be used in two main ways. The first it to investigate the details of the area under review by generating predefined reports that are available in most tax software. The second is to confirm the reliability of the accounting records by testing the integrity and accuracy.
Method of Transfer
As with most businesses, the IRS can accept data in a number of ways. This includes CDs, thumb drives, memory cards, and external hard drives.
At first glance, a business may be apprehensive about providing the IRS access to its electronic records. However, providing this access has a couple of potential benefits to the taxpayer.
- Reduced Burden – As mentioned previously, one of the ways the electronic records will be used is to generate the reports used in the auditing process. As a result, the number of information requests being made by IRS agents should be reduced since they will have the ability to create reports themselves. Businesses should no longer be responsible for preparing the paper versions of these reports.
- Improved Efficiency and Faster Turnaround – The reduction in information requests and the ability of agents to generate their own reports should improve the efficiency of audits since there will be less downtime between when information is requested and when it is received. This in turn should result in faster resolutions to audits.