IRS Examinations of Small Businesses and Their Electronic Accounting Files

Editor: Michael D. Koppel, CPA, MSA, MBA, PFS, CITP

Procedure & Administration

In 2010, the IRS Small Business/Self-Employed (SB/SE) Division greatly expanded its enforcement capabilities by requesting the electronic accounting software files of small businesses under examination. Initially, this initiative was limited to QuickBooks and Peachtree software; however, the IRS has expanded its capabilities to include other programs. Unlike the more focused requests for electronic data by the IRS’s Large Business and International (LB&I) Division involving examinations of large businesses, the SB/SE program requires the small business to submit the entire accounting software file. The number of examinations in which the IRS has requested a complete copy of the taxpayer’s electronic accounting files has increased significantly in the past several months.

CPAs have a number of concerns about this program. Chief among these are:

• The wide range of data included in the electronic file, including nonaccounting information such as customer data; and
• The number of years of data, outside those under examination, that are potentially available to the examiner.

Currently there is only limited guidance from the IRS available to practitioners representing their clients in examinations under this program. Some information about the program is available on the IRS website in the form of FAQs (“Use of Electronic Accounting Software Records; Frequently Asked Questions and Answers”). In addition, on September 1, 2011, the IRS posted a field guidance memorandum to examination area directors about requesting a copy of a taxpayer’s electronic accounting file (SBSE-04-0911-086).

The AICPA continues to work with the IRS to address the many issues surrounding these examinations and the need for more published guidance. For example, on September 8, 2011, the AICPA hosted a meeting with representatives of the accounting software industry and the IRS to address the concerns of CPAs and their clients regarding the program.

If a small business client receives an information document request (IDR) seeking a copy of his or her electronic software, the practitioner’s first step should be to discuss the issue with the client. It is important to remember that it is the client’s records that the IRS is requesting. Accordingly, after a full discussion of the issues, the client should be fully engaged and involved in the decision of how to respond to the IDR.

In representing a client in an SB/SE examination where an electronic copy of the accounting software file has been requested, a CPA may discuss the issue with the IRS examiner, group manager, or even the territory manager just as with any other items contained in the IDR. If the taxpayer’s electronic records are inadequate or not conducive to an efficient examination, this would be the time to raise the issue and suggest alternatives to the agent.

It is too early in the program to know how often these discussions have proven successful in eliminating the software request made under an IDR. However, the IRS has stated that an electronic copy of accounting software is not applicable in all cases. For example, in a limited focus examination involving only the verification of a few deductions, it is unlikely that a copy of the taxpayer’s entire accounting software is necessary for an efficient completion of the examination. Conversely, a request to provide the data in an alternative format that is based on the IRS’s authority to obtain the complete electronic file will most likely be denied.

Items to include in the discussion with clients include their rights as taxpayers, the authoritative powers of the IRS, and the possible ramifications of the various courses of action. For example, while it should not influence an examiner’s handling of the case, an aggressive resistance to providing a copy of the software could set a negative tone for the examination. However, providing a complete copy of the software could expand the scope of the exam if, as a result of having the full accounting file, the agent identifies transactions for further scrutiny.

If the taxpayer does not voluntarily provide the information requested in an IDR, the IRS may choose to exercise its authority to issue a summons to obtain the file (Sec. 7602(a)). Again, it is too early in the program to know when the IRS will exercise this power; however, the IRS recently was successful in enforcing a summons related to the submission of the accounting software of a small business (Rouse, No. 8:11-MC-00046-T-24AEP (M.D. Fla. 6/27/11)). This success may encourage the IRS to seek summons action to obtain the electronic software files of small businesses.

If a copy of the client’s accounting software is going to be submitted to the IRS as a result of an examination, the files for prior years should be condensed as provided for in the current IRS guidance (FAQ 13). The condensing of files should be limited to years not under examination.

Finally, the CPA should make sure that in representing a client, his or her actions do not violate the provisions of Circular 230. If the client makes the decision to oppose the request for a copy of the electronic accounting software by not submitting it in its entirety or submitting it in an altered manner (other than condensing data as described in FAQ 13), the IRS clearly states in FAQs 9 and 10 that the practitioner’s actions in the matter could be a Circular 230 violation.

EditorNotes

Michael Koppel is with Gray, Gray & Gray, LLP, in Westwood, MA.

For additional information about these items, contact Mr. Koppel at (781) 407-0300 or mkoppel@gggcpas.com.

Unless otherwise noted, contributors are members of or associated with CPAmerica International.