Documentation and recordkeeping for tax practitioners

Editor: Stephen P. Valenti, CPA

During the course of their work, tax practitioners accumulate volumes of paper documents and electronic files (hereinafter collectively referred to as records). This often leads to questions such as:

• What records are required to be retained?
• In addition to records that must be retained, what other records are prudent to be retained?
• How long should the records be retained?
• How can records be protected securely?
• How should requests for the retained records be addressed?

A tax practitioner’s records can be loosely categorized into two groups:

• Firm business records; and
• Work product and documentation records.

This column focuses on discussing these questions relative to work product and documentation records.

Recordkeeping requirements

There is no single comprehensive list of the records a tax practitioner must retain in the Internal Revenue Code or other authoritative source that is easily referenced. Rather, the requirements are contained throughout the Code and the Treasury regulations, based on topic. When considering recordkeeping requirements, tax practitioners should focus on the tax returns or claims for refunds for which they are a tax preparer as defined in Sec. 7701(a)(36).

A common assumption is that tax preparers are required to retain a copy of every tax return they prepare. However, Sec. 6107(b) requires that the tax preparer retain a completed copy of any return or claim for refund or maintain a list with the names and taxpayer identification numbers of the taxpayers for whom the returns or claims were prepared.

While keeping an actual copy of the tax return or claim for refund prepared might not be required, it may be prudent to do so, as discussed in a following section of this column. The return copies or the list must be maintained for three years after the close of the return period (as defined in Sec. 6060(c)). Unfortunately, the term “return period” as defined for this section is most likely not the period that most practitioners would anticipate. Rather, it is the 12-month period beginning on July 1 of each year and is unrelated to the tax return period or the tax return deadline.

For example, a tax preparer prepares and delivers an individual 2022 return in August 2023. The “return period” per the Sec. 6060(c) definition ends on June 30, 2024, so a copy of the return (or the list) would need to be maintained until June 30, 2027. A tax practitioner who fails to retain a copy or list as required by Sec. 6107(b) may be assessed a penalty of $50 for each failure, with a maximum penalty for any return period of $25,000 (Sec. 6695(d)).

Several other Code sections and/or Treasury regulations require specific record retention. For instance, if a tax preparer prepares a return that includes the head-of-household filing status, the earned income tax credit (EITC), the child tax credit, the additional child tax credit, the credit for other dependents, or the American opportunity tax credit, Form 8867, Paid Preparer’s Due Diligence Checklist, is required.

Specific record-retention requirements encompassing the five types of records to be maintained and the length of time those records must be kept (generally, three years) are detailed in Regs. Sec. 1.6695-2(b)(4)(ii). Additional explanatory information, interview tips, and best practices are available in IRS Publication 4687, Paid Preparer Due Diligence, and the Tax Preparer Toolkit on EITC Central. It is critical for tax practitioners to be aware that the definition and conclusion of the three-year retention period under this section is different from the three-year retention period under Sec. 6107(b). Another example of varying time requirements is Sec. 6112, which mandates a sevenyear recordkeeping requirement for the maintenance list that material advisers of reportable transactions must maintain.

When the tax practitioner is also an electronic return originator (ERO), there are additional record-retention requirements. For instance, an ERO must keep the signed copy of Forms 8453, U.S. Individual Income Tax Transmittal for an IRS e-file Return; 8879, IRS e-file Signature Authorization; and 8878, IRS e-file Signature Authorization for Form 4868 or Form 2350, for three years as well as other items such as the acknowledgment file for IRS-accepted returns. For additional details, practitioners should refer to IRS Publication 1345, Authorized IRS e-file Providers of Individual Income Tax Returns. EROs will also want to consider any applicable state retention rules.

Records to consider retaining

Most of the records that a tax practitioner retains will generally not fall into a mandatory retention category. Instead, they will be records that are prudent to keep, based on the tax practitioner’s professional judgment. Considerations in deciding which records to keep should include whether the records may assist the tax practitioner in providing continuing services to clients, as well as whether records may assist in any potential future defense. The types of records that it would generally be considered a best practice to retain include:

• Deliverables provided to a client (e.g., tax returns, written tax advice);
• Substantive communications with the client;
• Workpapers with calculations that support the deliverables;
• Workpapers with calculations that could affect future years, such as loss and credit carryforward calculations;
• Research that supports the conclusions reached within the deliverables;
• Executed engagement contracts that describe the scope of services to be provided to the client;
• Evidence that the deliverable was provided to the client; and
• Records required to be kept per the IRS, as described above.

In evaluating record retention, the practitioner should also consider professional standards. As an example, while the AICPA Statement on Standards for Tax Services (SSTS) No. 7, Form and Content of Advice to Taxpayers, does not include a discussion on record retention, the FAQs to SSTS No. 7 do state: “Where the taxpayer only requests oral advice, it is recommended that the member contemporaneously document the advice in written form in the taxpayer’s file.”

Just as important as considering which records should be retained is the consideration of which documents should not be retained:

• Client-provided original records should be returned to the client and not retained; and
• Draft or nonfinal versions of documents generally should not be retained unless they were provided to the client.

In addition, careful review should be undertaken regarding email correspondence. If an email includes documentation of services provided, whether it is tax advice or evidence that deliverables were provided in a timely manner to a client, the email should be stored with the other engagement records. Just as importantly, once it is stored with the other engagement records, it should be deleted from email so it is correctly retained for the same period as other related records.

The AICPA provides a helpful resource to members titled Document Retention FAQs for Tax Practitioners, which addresses some basic questions about both firm business records and work product and documentation records.

Record-retention period

Once the tax practitioner has determined which records to retain, the next logical question is how long the records should be retained. While there is a strong professional rationale for keeping records, the records should not be maintained indefinitely. Several costs are involved in maintaining the records, including those for storage and for ensuring data security.

As discussed earlier, several Code sections require a tax preparer to retain the records for at least three years. This mirrors the standard statute of limitation for a taxpayer in Sec. 6501(a), which runs for three years after the filing date or the return due date (including extensions), whichever is later. However, in several circumstances, a longer statute of limitation may apply to a taxpayer.

For example, under Sec. 6501(e)(1)(A) (ii), the statute of limitation is doubled to six years if more than $5,000 of foreign income is not reported. The IRS can look back seven years relative to a loss on worthless securities or a bad debt deduction (Sec. 6511(d)(1)). While the length of the taxpayer’s statute of limitation does not impose any requirement on the tax preparer to retain the records for a similar period, it may be helpful to retain them longer than three years to assist clients should the need arise. Additionally, states may have a different and possibly longer statute of limitation that should be taken into consideration when determining the appropriate retention period.

A commonly mentioned retention period for tax practitioners is seven years and is suggested as a general guideline in the AICPA resource Document Retention FAQs for Tax Practitioners. Whatever period the tax practitioner ultimately decides upon, it should be applied consistently to both paper-based and electronic records.

As a best practice, it is recommended that tax practitioners create and maintain a written document-retention policy. Each year, records should be reviewed pursuant to the document-retention policy and appropriate records securely destroyed if the retention period has expired. Tax practitioners may refer to the AICPA Tax Section’s Document Retention Policy Template for Tax Practitioners for additional guidance.

Tax practitioners should also consider consulting with their liability insurance provider and/or legal counsel about the retention period as well as the practitioner’s written document-retention policy.

Additionally, if the practitioner or their firm also provides attest services, consideration needs to be provided as to whether hosting services are being provided to the client. For instance, providing a client access to the tax practitioner’s retained records via a client portal may be interpreted as hosting. A discussion of hosting services is beyond the scope of this column, but many resources are available on the topic via the AICPA website.

Keeping records secure

Considering the increase in identity theft and ransomware cases, the data a tax practitioner maintains can be an enticing target. A tax practitioner has a duty to maintain client confidentiality and the security of the client’s data. Moreover, under the safeguards rule of the Gramm-Leach-Bliley Act, P.L. 106-102, tax preparers must implement written security plans to protect client data. The AICPA provides a Security Plan template to assist in documenting a plan. It’s important to note that a security plan should apply not only to the information being used to provide services currently but also to all the records the tax practitioner retains from prior services performed with confidential client data. Therefore, the tax practitioner needs to include in an overall security plan how to keep the retained records secure so that only people who have a “need to know” can access the data. If tax practitioners do not have an overall security plan, consider consulting the Best Practices for Keeping Client Data Secure resource in the AICPA resource section for some starting points.

It is important to also consider security when disposing of the records once the retention period has lapsed.

Client requests for records

Even though a practitioner has provided the deliverables to the client and returned the original client records, clients will often request records from the tax practitioner. When responding to a request for records from a client, practitioners should consult the AICPA Code of Professional Conduct’s Revised “Records Requests” interpretation (ET §1.400.200) under the “Acts Discreditable Rule” (ET §1.400.001), effective July 31, 2021.

Four key definitions from paragraph .01 of the “Records Requests” interpretation are important to understand and apply to the situation:

c. Client-provided records are accounting or other records, including hardcopy and electronic reproductions of such records, belonging to the client that were provided to the member by, or on behalf of, the client.

d. Member-prepared records are accounting or other records that the member was not specifically engaged to prepare and that are not in the client’s books and records or are otherwise not available to the client, thus rendering the client’s financial information incomplete. Examples include adjusting, closing, combining, or consolidating journal entries (including computations supporting such entries) and supporting schedules and documents that the member proposed or prepared as part of an engagement (for example, an audit).

e. Member’s work products are the deliverables set forth in the terms of the engagement, such as tax returns.

f. Working papers are all other items prepared solely for purposes of the engagement and include items prepared by the

i. member, such as audit programs, analytical review schedules, and statistical sampling results and analyses.

ii. client at the request of the member and reflecting testing or other work done by the member.

Upon receiving a client request for records, a member is generally required to provide the client with client-provided records, member-prepared records, and the member’s work product (the first three definitions above). Member-prepared records and the member’s work product may be withheld in certain circumstances, such as if fees are due, as detailed further on in the section. Client-provided records may not be withheld. It is critical to note that the member is not required to provide the client with their working papers (subject to federal and state laws and contractual agreements that may impose additional requirements).

When applying these rules, the most challenging determination often is whether a record is a member-prepared record or a working paper. With the prevalent use of tax preparation software and other electronic tools, the dividing line between a member-prepared record and a working paper seems harder to divine. The Electronic Records section within the AICPA guidance Frequently Asked Questions: General Ethics as of March 18, 2022, may be helpful to the member in determining whether a record is a member-prepared record or a working paper. It addresses seven common questions that provide useful guidance in thinking through the analysis. For instance, Question 1 addresses whether the electronic data file within a member’s tax preparation software is a member-prepared record or a working paper and concludes that it is a working paper. Just as important, the explanation of why it is a working paper (even though it contains tax data obtained from the client’s records) provides a guideline to help the tax practitioner work through similar questions.

Practices to consider

The topic of documentation and recordkeeping for a tax practitioner can be quite complex. To help with the application of these concepts, here are some practices to consider:

• Determine the types of documentation to be retained;
• Depending on the size of the practice, create a checklist to assist staff when documenting the services provided;
• Create a written record-retention plan, including specific recordretention periods; and
• Set aside time in less busy periods to annually review retained documents for possible disposal.

Contributors

Karen L. Jones, CPA, is director, One Firm Risk Organization at PricewaterhouseCoopers LLP in Washington, D.C. Stephen P. Valenti, CPA, is professor emeritus of accounting at New York University. Both are members of the AICPA Tax Practice Responsibilities Committee. For more information about this column, contact thetaxadviser@aicpa.org.