IRS Updates Electronic Record Audit Rules
IRS Updates Electronic Record Audit Rules….talk about a sneaky time to update IRS audit rules, there are some substantial new additions on the IRS website at Use of Electronic Accounting Software Records; Frequently Asked Questions and Answers. Its probably worth starting the discussion with this little gem:
Q14. Can a taxpayer or representative condense or “clean up” the electronic accounting software data file before submission?
A: Many accounting software programs will condense old, closed transactions occurring prior to a manually selected date. For example, the closing of a prior year. Often this is done to reduce the size of the company data file. The process essentially removes the details of those transactions from the data file and replaces them with summary journal entries, allowing monthly financial statements to be created for old years if needed.
The ongoing data file (working file) will no longer have the details of old, closed transactions which occurred prior to the manually selected date. However, during the condensing process, the software creates a backup or archive copy of the company data file and this archive copy provides the original detailed records of each old transaction. If you do not have a complete understanding of your software’s condensing feature, please contact your software provider for additional guidance before using it.
Condensed data is not acceptable for the tax year(s) under audit. However, if you choose, the company data file can be condensed (through the clean up or purge feature) for dates prior to the year(s) under audit, as long as they do not include transactions created or changed for time periods under audit, or for transactions from prior years that have an effect on the years under audit.
If the scope of an audit is expanded, the IRS may request another backup file that was created prior to the date the company file was condensed or request a copy of the archive file created during the condensing process.
Internal Revenue Manual Sec. 4.10.3 Examination Techniques had a MAJOR AMENDMENT released on February 26, 2016 the summary table of major changes is in the front section here. An overview of the revision is:
- The purpose of this section is to provide guidelines for procedures and techniques that should be used in conducting an effective examination.
- Auditing includes the accumulation of evidence for evaluating the accuracy of the taxpayer’s tax return(s). Evidence takes many forms, including the taxpayer’s testimony, the taxpayer’s books and records, the examiner’s own observations and documents from third parties.
- It is important to obtain sufficient competent evidence to determine the accuracy of the taxpayer’s return. Every examiner must determine the appropriate amount of evidence to accumulate and establish the proper depth of the examination. This decision is a matter of judgment and is important because of the prohibitive cost of examining and evaluating all available evidence. See IRM 188.8.131.52 (6) for additional guidance on determining the depth of the examination.
- Methods for accumulating evidence include:
- Analytical Tests — such as analysis of balance sheet items to identify large, unusual, or questionable accounts. Analytical tests use comparisons and relationships to isolate accounts and transactions that should be further examined or determine that further inquiry is not needed.
- Documentation — such as examining the taxpayer’s books and records to determine the content and accuracy of items claimed on the tax return.
- Inquiry — such as interviewing the taxpayer or third parties. Information from independent third parties can confirm or verify the accuracy of information presented by the taxpayer.
- Inspection — such as physically examining the taxpayer’s assets, e.g., inventory or securities.
- Observation — such as conducting a tour of the taxpayer’s business to observe the taxpayer’s daily business operations.
- Testing — such as tracing transactions to determine if they are correctly recorded and summarized in the taxpayer’s books and records.
Factors to consider when choosing an examination technique are:
- Will the examination technique provide the needed evidence?
- Will the benefits derived from using a particular technique justify the associated costs to both the examiner and the taxpayer?
- Are there less expensive alternatives that will provide the same evidence?
We haven’t seen anything from the major commentators, but this is a shot across the bow for taxpayers that are advised by non-CPA’s and EA that don’t have thirty hours of accounting, that the IRS is going to scrub through electronic changes to files.