Legal reguirements for computer records containing federal tax information: An update

ARMA Records Management Quarterly, Jul 1998 by Skupsky, Donald S

NOTICE: This article contains information related to sensitive and important legal issues. No section of this article should be construed as providing legal advice. All legal decisions related to records and information management should be reviewed by competent legal counsel.

In previous articles, I reviewed the legal requirements related to the legal requirements for computer records,1 generally, and to tax records,2 specifically. The legal requirements related to the admissibility of computer records in evidence have remained the same since the previous article. In 1986, however, the Internal Revenue Service modified its requirements related to computer records maintained for tax purposes. Since many computer records contain taxrelated information, this regulation impacts many computer systems in the United States.

SUMMARY OF COMPUTER REQUIREMENTS FOR TAX RECORDS

Internal Revenue Service Revenue Procedure 86-19 replaced the previous Revenue Procedure 6412 (adopted in 1964) with a new procedure which became effective April 7, 1986. The requirements of this new procedure are substantially different and will necessitate modifications in some existing computer systems. The following summary highlights the key points found in this revenue procedure as contrasted with the previous one:

1. All computer records must be retained by the taxpayer in a retrievable, machine-sensible form.

Previously, taxpayers were not required to maintain the tax information in computer-readable format for review by the Internal Revenue Service. Instead, only visible tax records and audit trails were required to ensure that information was correctly processed.

Under the new regulation, the Internal Revenue Service can request your computer tapes or disks for their analysis and review. The computer-readable information, as indicated below, must therefore be fully documented and maintained in a retrievable and usable form. Even when a service bureau or time-sharing service is used, the taxpayer will still be responsible for maintaining this information as indicated.

2. Documentation must be provided describing the computerized accounting system including record formats, flowcharts, label descriptions, software program listings, software program changes maintained in chronological order, and detailed charts of accounts. Audit trails should be provided to ensure that the steps leading from detailed to summary information can be examined by IRS.

Although the wording for this new requirement is different than the previous one, the nature of the documentation requirement is similar. The reader should note, however, that the IRS specifically requires that major changes in the computer system be documented and preserved in chronological order. This means that each major version of the software programs must be retained for later IRS review. No guidelines are provided, however, to differentiate between a major and a minor software change.

3. The computer records should be retained "so long as the contents may become material in the administration of any Internal Revenue law."

The Internal Revenue Service suggests that the retention period should match the statute of limitations for federal tax purposes (generally three to six years3), but will be extended in certain circumstances such as fixed assets, insurance loss reserve, and voluntary extension of the audit period.

4. The accounting records should also be retained in visible form, either on paper or microfilm.

Although the requirement for creating a visible or hardcopy record has been preserved from the original regulation, the Internal Revenue Service stresses that the maintenance of a visible record does not replace the requirement for the retention of machine-sensible records. Microfilm may be retained in place of paper records.

5. All computer records maintained for tax purposes should be clearly labeled and maintained in a secure environment, with backup files stored off-site.

While this requirement provides details related to the preservation of the computer information, the requirements actually conform to good computer practices for records storage and vital records protection.

6. The computer records must be maintained in a retrievable form for the entire time they are needed for tax purposes. Even if the taxpayer converts to a new computer system, the computer records must be converted to that new format or maintained in some other format that can still readily be retrieved.

This requirement is probably the most difficult and costly one to implement. Whenever an organization converts to a new computer system, the old computer tapes and disks may have tb be converted to the new format. Under the previous regulation, the taxpayers could simply produce visible output from the records and not worry about the various computer tapes or disks maintained in the storage area. Under the new regulation, all computer-readable material relevant for tax purposes must be maintained in a format which is readily retrievable. This will create a tremendous burden for some companies since audits are frequently extended more than ten years while computerized accounting systems change substantially approximately every three years.