IRS Issues Accounting Software Examination Guidance, Meets with AICPA

The IRS Small Business/Self-Employed Division (SB/SE) has issued guidance for its field examiners on when to request backup files of taxpayers’ accounting software during an examination, what the limits are on reviewing those electronic files, and how examiners must safeguard those records (SBSE-04-0911-086). The IRS has also updated its online FAQs about its examination of accounting software data.

The IRS has instituted a program to request accounting software files when examining certain small business taxpayers, and SB/SE examiners can now accept and read data files from accounting software packages used by most small businesses. The SB/SE memorandum reminds examiners to exercise professional judgment when deciding what taxpayer records to request, but it says, “If the taxpayer uses one of the accounting software products the IRS can read, examiners should generally request a copy of the taxpayer’s original accounting software backup file.” The FAQs state that backup files will likely be requested “in broader scope audits, such as when verifying gross income” but may not be necessary in those of more limited scope.

The memorandum says that because many software products do not allow users to back up data for only a specified period, backup files typically contain data for tax years before and after those under examination. It instructs examiners to “only review data relevant to the year(s) under examination,” but provides an exception for transactions in the month before and after the tax year or other period under examination.

The memorandum also discusses what to do when backup files contain privileged communications. It reminds examiners that backup file data is protected under federal disclosure laws like all other records submitted to the IRS during an examination, and that the IRS has authority to issue a summons for electronic records as well as paper records.

On September 8, the AICPA hosted a meeting with senior IRS officials and several software developers focusing on ways to minimize the amount of data turned over to the Service upon a government request for the accounting software file of a small business under examination. The AICPA discussed the need for the software developers to consider making modifications to their accounting software products to make it easier for small businesses to provide the IRS with only the data that is responsive and relevant to an IRS examination—but not more. In addition to the meeting, members of the AICPA Tax Division staff have been in active dialogue throughout the year with the IRS on the need to provide clearer guidance to taxpayers and to IRS revenue agents in the field on the details of the Service’s accounting software examination program.