IRS Use of Small Business Electronic Accounting Files in Audits

Since 2010, the IRS has been requesting small business electronic accounting files in audits. IRS agents have even been trained in using QuickBooks and Peachtree accounting files in examinations of small business taxpayers. The main issue most practitioners have with providing these files is that they can't limit the file to the year under examination. Practitioners are concerned because many believe that IRS agents will review transactions in years not under examination.

Before 2010, the IRS limited its use of electronic accounting records in audits to large business taxpayers - mainly those with assets greater than $10 million. However, because most small businesses use off-the-shelf or cloud-based accounting software, the IRS believes that it can make audits more efficient by using electronic records instead of having auditors go through taxpayer-provided printouts of financial records.

The IRS has trained 1,100 of its agents -- about one agent per each local audit group -- to be proficient in QuickBooks and Peachtree software programs. At the initial audit contact, IRS auditors are requesting back-up files that contain the year under examination. The auditor will run reports against the data to look for large, unusual and questionable items. The IRS will also analyze the records for recordkeeping accuracy. This highlights another concern for practitioners: client errors. Many business owners are using software programs to reduce bookkeeping costs. As a result, there may be many errors that accountants must correct before completing the tax return. The IRS may perceive these corrections as taxpayer noncompliance, which may cause the IRS to use additional audit techniques to verify the accuracy of the accounting records.

Some taxpayers and practitioners are resisting providing entire back-up files to the IRS, saying that the entire file isn't necessary. However, there is no alternative unless the taxpayer is willing to find an outside service to parse the data for the year under examination only. Some practitioners are providing these redacted files with summary data from prior and subsequent years. In some cases, the IRS appears to be accepting this format, but this is not the formal IRS position.

The IRS clearly states its position in "Use of Electronic Accounting Software Records; Frequently Asked Questions and Answers," on IRS.gov:

"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."

Practitioners can expect to see an increase in IRS requests for back-up files and should also expect the IRS to clarify which data fields are acceptable to provide in an audit. Small business accounting software companies will most likely build options into their programs in the future.

In the meantime, practitioners should alert their clients that the IRS will scrutinize bookkeeping practices if their clients are selected for audit. Clients will need to be more careful about how they enter transactions and should be prepared to clearly explain any voided or restated transactions.

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