IBLS Editorial Associates
The United States requires E-commerce sellers to store their business records electronically. To have confidence in the processes and methodology used to store records electronically, the Internal Revenue Service promulgates acceptable standards of electronic record keeping for tax purposes.
Today, many businesses use electronic data interchange (EDI) as a means of storing and transferring data. Through EDI, sellers and consumers complete transactions and exchange data and documents, including sales invoices and purchase orders. EDI reduces the need to prepare and retain hard-copy documents, as they can be stored electronically.
E-commerce transactions are stored on a computer-readable medium, such as a disk, tape, CD, or DVD.
The issue of whether keeping electronic records meet the requirements set forth in various applicable statutes and regulations and what steps must be taken in order to bring electronic records within compliance of said statues and regulations must be addressed.
In response to the above concerns, the IRS has proposed several rules relating to generating and retaining electronic documents. Accordingly, organizations that use electronic medium for transactions have to generate adequate electronic documents to support those transactions and also should retain these documents for IRS audit and verification. Violation of these regulations can lead to significant cost and penalties.
What is Electronic Record Keeping?
It is very difficult to keep and maintain electronic records given the nature of the computer based storage material. It is quite possible that such records might get lost, destroyed, or altered. There is also the risk that an untrained or careless employee may accidentally use a backup disk or tape, overwrite a historical file, and in the process erase all proof of any transactions.
What are the requirements recognized by IRS for Electronic Record Keeping?
Section 6001 of Internal Revenue Code requires that every person who is liable for any tax imposed shall keep such records, render such statements, make such returns, and comply with such rules and regulations as the Secretary may from time to time prescribe.
Other requirements include Treas. Reg. Sec. 1.6001-1(a), which states that the taxpayer should keep permanent books of accounts or records. Further, such records should sufficiently establish the amount of gross income, deductions, credits, or other matters required to be shown on a tax or information return.
In addition to the general requirements stated above, Rev. Rul. 71-20 provides what electronic data can come under the purview of the meaning of IRC Sec. 6001 of the Code and Reg. Sec. 1.6001-1. The Rule provides that machine-sensible data media used for recording, consolidating, and summarizing accounting transactions and records within a taxpayer's automatic data processing system (ADP) are the records within the meaning of abovementioned sections.
The IRS also provides important guidelines on machine-sensible records in Rev. Proc. 91-59. Rev. Proc. 91-59 becomes applicable if the taxpayer is having assets of $10 million or more. It also applies to taxpayers with assets of less than $10 million if:
(1) The books of accounts and records of the transactions are only available in machine-sensible format, or
(2) Computations based upon machine-sensible records can only be reasonably verified or recomputed by use of a computer, as in LIFO inventory valuations or
(3) The taxpayer is notified by the IRS that machine-sensible records must be retained.
What are the hardware requirements?
The IRS has not provided any particular requirements for hardware settings. However, it is expected that the taxpayer have the suitable hardware to process the electronically retained records at the time of an IRS examination. Moreover, it is necessary to inform the IRS if there is any decrease in ability to process such records.
It is important that taxpayers place all necessary computer resources at the disposal of the IRS during a review thereby enabling all the relevant electronic records (records retained in machine-readable form) to be processed. Violation of this requirement will be treated same as that of violation of the record keeping requirements under Section 6001.
What are the penalties for non-compliance of IRS requirements?
Non-compliance of requirements of Rev. Proc. 91-59 can result in both a civil and a criminal penalty. Taxpayers may be subject to the civil penalty enumerated in IRC Sec. 6662 (a). This section provides a penalty of 20% on the portion of an underpaid tax due to negligence or intentional disregard of relevant rules and regulations.
With regard to criminal penalties, IRC Sec. 7203 provides that if taxpayer willfully fails to keep records or willfully fails to supply information, as required by the IRC, it is deemed to be a commission of a misdemeanor (misconduct). The wrongdoer may become subject to imprisonment up to one year and/or a fine of $25,000 ($100,000 fine is for corporations), plus the cost of prosecution.