IRS UPDATES ADP RECORDKEEPING REQUIREMENTS.

Rev. Proc. 91-59

SECTION 1. PURPOSE

01 The purpose of this revenue procedure is to update Rev. Proc. 86-19, 1986-1 C.B. 558, and to specify the basic requirements that the Internal Revenue Service considers to be essential in cases where a taxpayer's records are maintained within an Automatic Data Processing (ADP) system. Rev. Proc. 86-19 provides guidelines for record requirements to be followed in cases where all or part of the accounting records are maintained within an ADP system. References to ADP systems include all accounting and/or financial systems and subsystems that process all or part of a taxpayer's transactions, records, or data by other than manual methods.

02 The technology of ADP has evolved rapidly, and new methods and techniques are constantly being devised and adopted. The requirements set forth in Section 5 of this revenue procedure are intended to ensure that all machine-sensible records generated by a taxpayer's ADP system are retained so long as they may be or may become material in the administration of any internal revenue law. These requirements will be modified and amended as needed to keep pace with developments in ADP systems.

SEC. 2. BACKGROUND

01 Section 6001 of the Internal Revenue Code provides that every person liable for any tax imposed by the Code, or for the collection thereof, shall keep the records that the Secretary may from time to time prescribe.

02 Rev. Rul. 71-20, 1971-1 C.B. 392, establishes that all machine-sensible data media used for recording, consolidating, and summarizing accounting transactions and records within a taxpayer's ADP system are records within the meaning of section 6001 of the Code and section 1.6001-1 of the Income Tax Regulations, and are required to be retained so long as the contents may be material in the administration of any internal revenue law.

SEC. 3. SCOPE

01 This revenue procedure encompasses all types of data processing systems including, but not limited to, microcomputer systems, Data Base Management Systems (DBMS), and all systems using Electronic Data Interchange (EDI) technology. For purposes of this revenue procedure: DBMS means a software system that creates, controls, retrieves, and provides accessibility to data stored in a data base; and EDI technology means the computer-to-computer exchange of business information.

02 The utilization of a service bureau, time-sharing service, or value-added network does not relieve the taxpayer of the responsibilities described in this revenue procedure.

03 A taxpayer with assets of $10 million or more at the end of its taxable year shall comply with the record retention requirements of Rev. Rul. 71-20 and the provisions of this revenue procedure. For purposes of this revenue procedure, a controlled group of corporations, as defined in section 1563 of the Code, will be considered to be one corporation and all assets of all members of the group will be aggregated.

04 A taxpayer that has assets of less than $10 million shall comply with the record retention requirements of Rev. Rul. 71-20 and the provisions of this revenue procedure if any of the following conditions exist:

(1) information required by section 6001 of the Code is not in the hardcopy books and records, but is available in machine- sensible records;

(2) machine-sensible records were used for computations that cannot be reasonably verified or recomputed without using a computer (e.g., Last-In, First-Out (LIFO) inventories); or

(3) the taxpayer is notified by the District Director that machine-sensible records must be retained to meet the requirements of section 6001 of the Code.

05 The requirements of this revenue procedure pertain to all matters under the jurisdiction of the Commissioner of Internal Revenue including, but not limited to, income, excise, employment, and estate and gift taxes, as well as employee plans and exempt organizations.

06 The requirements of this revenue procedure are applicable to the machine-sensible records generated by a Controlled Foreign Corporation (CFC), a domestic corporation that is 25 percent foreign- owned, and foreign corporations engaged in a trade or business within the United States at any time during a taxable year because the definition of "records" in sections 964(c), 982(d), 6038A, and 6038C of the Code and the regulations thereunder has the same meaning as "records" as used in section 6001 of the Code and section 1.6001-1(a) of the regulations.

07 Machine-sensible records used by an insurance company to determine losses incurred under section 832(b)(5) of the Code shall be retained in accordance with the requirements of this revenue procedure and Rev. Proc. 75-56, 1975-2 C.B. 596. For this purpose, the machine-sensible files for a particular taxable year include the files for that year and the seven preceding years, all of which shall be retained so long as they are material to the examinating of the federal tax return. See, section 5.06 for a discussion of materiality.

08 The requirements of this revenue procedure are applicable to any sections of the Code that have unique or specific recordkeeping requirements. For example, machine-sensible records maintained by the taxpayer to meet the requirements of section 274(d) relating to the amount, time, and place of a business expense must meet the requirements of this revenue procedure.

SEC. 4. DISTRICT DIRECTOR AUTHORITY

01 In the case of a taxpayer that has less than $10 million in assets at the end of its taxable year, the District Director may notify a taxpayer that machine-sensible records must be retained to meet the requirements of section 6001 of the Code, and that Rev. Rul. 71-20 and the provisions of this revenue procedure apply to that taxpayer. Subsequent failure to comply with this notification may result in the imposition of the penalties described in section 7.

02 The District Director has the authority to enter into or revoke a record retention limitation agreement with the taxpayer to modify or waive all or any of the specific requirements in this revenue procedure. The taxpayer remains subject to all requirements of this revenue procedure that are not specifically modified or waived by a record retention limitation agreement. A taxpayer that has questions regarding the application of this revenue procedure to a specific factual situation should contact the appropriate District Director.

(1) A record retention limitation agreement does not apply to a subsidiary company acquired, or accounting and tax systems added, subsequent to the completion of the record evaluation (see section 3.03 below) upon which the agreement is based. All machine-sensible records produced by a subsequently acquired company or a subsequently added accounting and tax system whose contents may be or may become material in the administration of the Code shall be retained by the taxpayer who signed the agreement until a new evaluation is conducted by the District Director.

(2) Upon the disposition of a subsidiary, the files being retained for the Service by, or for, the disposed subsidiary shall be retained by the taxpayer until a new evaluation can be made by the District Director.

03 To determine if a taxpayer may limit its retention of machine-sensible records, a record evaluation may be conducted by the District Director. This evaluation of the data processing and accounting systems may be initiated by the District Director or requested by the taxpayer, and is not an "examination," "investigation," or "inspection" of the books and records within the meaning of section 7605(b) of the Code because the evaluation is not directly related to the determination of tax liability for a particular taxable period.

04 The District Director may periodically initiate tests to establish the authenticity, readability, completeness, and integrity of the machine-sensible records retained as required by this revenue procedure. These tests may include the testing of EDI and/or other procedures, and a review of the internal controls and security procedures associated with the creation and storage of the records. These tests are not an "examination," "investigation," or "inspection" of the books and records within the meaning of section 7605(b) of the Code because these tests are not directly related to the determination of tax liability for a particular taxable period.

SEC. 5. MACHINE-SENSIBLE RECORDKEEPING REQUIREMENTS

01 All machine-sensible records whose contents may be or may become material to the administration of the Code shall be retained by the taxpayer. The retained records shall be in a retrievable format that provides the information necessary to determine the correct tax liability. The taxpayer shall ensure that the details and the source documents underlying any summary accounting data may be easily identified and made available to the Service upon request.

02 Documentation that provides a complete description of the ADP portion of the accounting system, including all subsystems and files that feed into the accounting system, shall be retained and made available to the Service upon request. The statements and illustrations as to the scope of operations shall be sufficiently detailed to indicate:

(1) the application being performed;

(2) the procedures employed in each application;

(3) the controls used to ensure accurate and reliable processing; and

(4) the controls used to prevent the unauthorized addition, alteration, or deletion of retained records.

03 The following specific documentation for all retained files shall also be kept:

(1) record formats (including the meaning of all "codes" used to represent information);

(2) flowcharts for a system and a program;

(3) label descriptions;

(4) source program listings of programs that created the retained files;

(5) detailed charts of accounts (for specific periods);

(6) evidence that periodic checks of the retained records that are prescribed in section 5.08 were performed; and

(7) evidence that the retained records reconcile to the books and the tax return. This reconciliation shall establish the relationship between the total of the amounts in the retained records by account to the account totals in the books and to the tax return.

04 Any change to the ADP system which affects the accounting system and/or subsystems, together with their effective dates, shall be documented in order to preserve an accurate chronological record. This documentation shall include any changes to software or systems and any changes to the formats of files.

05 In addition to the documentation described in section 5.02 through 5.04, the Service may require that the taxpayer furnish any other evidence (e.g., internal audit reports) that pertains to the authenticity and integrity of the records.

06 Machine-sensible records are required to be retained until their contents are no longer material to the administration of the Code. At a minimum, this materiality continues until the expiration of the statute of limitations, including extensions, for each tax year. In certain situations, records should be kept for a longer period of time. For example, records that pertain to fixed assets, losses incurred under section 832(b)(5) of the Code, and LIFO inventories should be kept for longer periods of time.

07 All machine-sensible records that must be retained shall be clearly labeled and stored in a secure environment. For example, supplemental labels with the statement "Tax Year 19XX Records -- Retain for IRS until ________" or "Retain for IRS, Consult Tax Manager Before Releasing" should be used and affixed to each tape reel, cartridge, disk pack, diskette, or other device being retained, and a retention date should be written on the internal label. Back-up copies of machine-sensible records retained for the Service should be stored at an off-site location. The Service recommends that taxpayers refer to the National Archives and Record Administration's (NARA) standards for additional guidance on the maintenance and storage of electronic records. See, Standards for the Creation, Use, Preservation, and Disposition of Electronic Records, 36 C.F.R. Ch. XII, Part 1234, Subpart C (1990).

08 The taxpayer shall make periodic checks on all records retained for the Service. The Service recommends using the NARA standard for making periodic checks of retained machine-sensible records. See, 36 C.F.R. section 1234.28(g)(4) (1990). In general, this standard requires a recordkeeper to annually select and test a random sample of all reels of magnetic tape to identify any loss of data, and to discover and correct the causes of data loss. In libraries with 1800 or fewer storage units (e.g., magnetic tape reels), a 20 percent random sample or a sample size of 50 units, whichever is larger, shall be read. In libraries with more than 1800 units, a sample of 384 units shall be read.

09 If any machine-sensible records required to be retained are lost, destroyed, damaged, or found to be incomplete or materially inaccurate, the taxpayer shall report this to the District Director and recreate the files within a reasonable period of time.

10 Although the NARA sampling standard referred to in section 5.08 is specifically for magnetic computer tape, the Service recommends that all retained machine-sensible media be randomly sampled and tested as described by NARA. A taxpayer whose data maintenance practices conform with the NARA standards and who loses only a portion of the data from a particular storage unit will not be subject to the penalties described in section 7. However, this taxpayer remains responsible for substantiating the information on its return as required by section 6001 of the Code.

11 The taxpayer must be able to process the retained records at the time of a Service examination. Processing shall include the ability to print a hardcopy of any record. When the data processing system that created the records is being replaced by a system with which the records would be incompatible, the taxpayer shall convert pre-existing records to a format that is compatible with the new system. Any changes in the ability to process the retained records shall be reported to the District Director.

12 The taxpayer shall provide the Service, at the time of an examination, with computer resources (e.g., terminal access, computer time, personnel, etc.) that are necessary for the processing of the retained records. Failure to provide these resources will be a failure to maintain books and records under section 6001 of the Code.

13 The use of a DBMS necessitates the implementation of procedures to ensure that appropriate records and documentation are retained. A taxpayer is in compliance with the provisions of this revenue procedure if a sequential file exists and is available to the Service. The sequential file shall contain the detail necessary to identify the underlying source documents. The process to create a sequential file should be reviewed by the District Director prior to destruction of the DBMS records. Sections 5.01 through 5.12 of this procedure shall apply to the resultant sequential file(s).

14 In addition to the documentation described in section 5.02 through 5.05, the following documentation pertaining to each DBMS system shall be retained:

(1) Data Base Description (DBD);

(2) Record layout of each segment with respect to the fields in the segment;

(3) Systems Control Language;

(4) Program Specification Block (PSB); and

(5) Program Communication Block (PCB).

15 In order to be in compliance with this revenue procedure, a taxpayer that uses EDI technology must retain machine-sensible records that, in combination with any other records (e.g., the underlying contracts, price lists, and price changes), contain all of the detailed information required by section 6001 of the Code. The extent of the detail in the retained electronic and other records, if any, must be equivalent to the level of detail contained in an acceptable paper record. For example, the retained records for an electronic invoice must contain identification of the vendor by name, invoice date, product description, quantity purchased, price, etc. The taxpayer may capture this information at any level within the accounting system provided the audit trail, authenticity, and integrity of the retained records can be established.

SEC. 6. IMPACT ON HARDCOPY RECORDKEEPING REQUIREMENTS

01 Except as otherwise provided in this section, the provisions of this revenue procedure do not relieve taxpayers of the responsibility to retain hardcopy records that are created or received in the ordinary course of business as required by existing law and regulations. Hardcopy records may be retained in microfiche or microfilm formal in accordance with the requirements outlined in Rev. Proc. 81-46, 1981-2 C.B. 621. These records are not a substitute for the machine-sensible records required to be retained by this revenue procedure.

02 Hardcopy records generated at the time of a transaction (e.g., credit card receipts) need not be retained if all the details relating to the transaction are subsequently received by the taxpayer in an EDI transaction and are retained by the taxpayer in accordance with this revenue procedure.

03 If hardcopy records are not produced or received in the ordinary course of transacting business (as may be the case when utilizing EDI technology), or are not retained pursuant to section 6.02, hardcopy printouts of computerized records need not be created unless requested by the Service. These requests may be made either at the time of an examination or in conjunction with the testing described in section 4.04.

04 Computer printouts that are created for validation, control, or other temporary purposes need not be retained.

SEC. 7. PENALTIES

The District Director may issue a Notice of Inadequate Records pursuant to section 1.6001-1(d) of the regulations if machine- sensible records are not properly retained as required by this revenue procedure. Failure to comply with the provisions of this revenue procedure may also result in the imposition of an accuracy related civil penalty under section 6662(a) of the Code that is attributable to negligence or disregard of rules or regulations as provided under section 6662(b)(1). A criminal penalty under section 7203 may also be applicable. See Rev. Rul. 81-205, 1981-2 C.B. 225, which explains the applicability of the predecessor of the section 6662(a) civil penalty and the section 7203 criminal penalty.

SEC. 8. EFFECT ON OTHER REVENUE PROCEDURES

Rev. Proc. 86-19 is superseded for taxable years beginning after December 31, 1991. However, if a taxpayer complies with this revenue procedure for prior taxable years, the taxpayer will be treated as having complied with Rev. Proc. 86-19 for those years.

SEC. 9. EFFECTIVE DATE

This revenue procedure is effective for taxable years beginning after December 31, 1991.

SEC. 10. EXAMINATION OFFICE CONTACT

All questions regarding this revenue procedure should be directed to the Office of the Assistant Commissioner (Examination). The telephone number for this office is (202) 566-6856 (not a toll- free number). Written questions should be addressed to:

     Assistant Commissioner (Examination)