Record Retention Policies: How Long Is Long Enough?

Editor: Valrie Chambers, Ph.D., CPA

Procedure & Administration

Tax professionals are frequently asked by their clients for guidance on document and record retention policies. A good record retention policy should meet various legal requirements as well as those of federal, state, and local taxing authorities. At the same time, however, the policies should strive for a cost-effective way of doing so. In advising clients on retention policies, the concern is often with keeping records too long, and because of the cost and logistical issues related to record retention, many taxpayers want to destroy outdated records as soon as possible. However, holding onto records can be beneficial, as illustrated in Byk (T.C. Summ. 2010-137 (2010)).

For more than 30 years, Donald J. Byk operated a dental practice. In 2007, he received a notice from the IRS asserting that he had not filed Form 941, Employer’s Quarterly Federal Tax Return, for the tax period ended June 30, 2000, almost seven years earlier. Upon receipt of the notice, the taxpayer contacted his accountant, who furnished a copy of the return in question. This retained copy was given to the IRS as evidence of earlier filing, but no remittance was included with the copy when it was submitted to the IRS in 2007.

The IRS treated the 2007 submission as an original return and on October 7, 2008, issued a Notice of Federal Tax Lien (NFTL) to Byk. The notice stated that the taxpayer had not fully paid the employment taxes related to the June 2000 Form 941. The taxpayer requested and was granted a collection due process (CDP) hearing. During the hearing, Byk asserted that the employment taxes in question had in fact been paid in 2000 when the original return was filed.

Approximately two months after the CDP hearing, the IRS issued a Notice of Determination Concerning Collection Action, which stated that the tax liability was valid and had not been paid.

In ruling in favor of the taxpayer, the Tax Court noted the following key facts:

• The IRS did not adequately show that it made an attempt to verify whether the return in question was timely filed and related taxes timely paid in 2000. The court noted that in conducting a CDP hearing, the Appeals officer must verify that the IRS timely assessed the liability, the taxpayer failed to pay the liability, the taxpayer was given a notice and demand for payment, and the taxpayer was given an NFTL filing. If these requirements are not met, the collection cannot proceed. The IRS did not provide Form 3050, Certification of Lack of Record, or other sufficient supporting information, something the IRS admitted in Tax Court is routinely done in similar matters.
• The IRS relied heavily on account transcripts of the taxpayer’s dentistry practice. However, the IRS’s expert was not able to explain how the transcript system worked and was unable to identify the meaning of various codes used in the transcript.
• The taxpayer had adequately raised the issue of verification of the liability in his petition and at trial.
• The IRS could not provide a reason for the length of time that passed between the tax period at issue and the IRS’s notification to the taxpayer that a Form 941 was not on file for the tax period in question.

The facts in this case do not appear to favor the IRS. As the court noted, “[a] clear record of relevant transactions is necessary in a section 6330 court proceeding.” The IRS failed to provide sufficient documentation to prove that the taxpayer had failed to timely file Form 941 and pay the tax. The taxpayer, on the other hand, was able to produce a copy of the Form 941 kept by his accountant, and he asserted that the original return was properly filed and the tax was paid. According to the court, the fact that the taxpayer was able to produce a copy of the return that was filed in 2000, along with the IRS’s inability to provide any satisfactory proof that he had not filed the return, raised questions about the validity of the IRS’s claims and an irregularity in the assessment procedure.

The taxpayer prevailed, primarily because, as the court stated, the IRS failed to prove “that all legal and procedural requirements were met in the assessment of the petitioner’s employment tax liability.” But this case is a reminder that document and record retention policies should adequately protect an entity from inappropriate or erroneous liability. Likewise, the retention period should be well thought out and followed accordingly.

For more on this topic, see Parker, “Record Retention,” 39 The Tax Adviser 841 (December 2008).

EditorNotes

Valrie Chambers is a professor of accounting at Texas A&M University in Corpus Christi, TX. Danny Snow is a member in charge of tax with Thompson Dunavant PLC in Memphis, TN. Mr. Snow is chair and Prof. Chambers is a member of the AICPA Tax Division’s IRS Practice and Procedures Committee. For more information about this column, contact Prof. Chambers at Valrie.Chambers@tamucc.edu.