The fight rages on as to whether the IRS has rights to elctronic files. It has been our position that the IRS does have rights to these files and extreme care should be given when you receive such requests.
Well, in Chief Counsel Advice (CCA) 201146017, the IRS has explored a number of issues concerning its ability to summon a taxpayer’s original electronic data files or the backup files (referred to here as “original electronic data files”) to obtain the associated meta data (data on data, including such information as who, when, and how the information was created). This supports the position that the IRS has rights to these data files and sets the stage for continued argument over this issue in 2012 and beyond.
This is an interesting opinion by the CCA and worth the read. The following is an overview of the matter.
Background. IRS may examine “books, papers, records or other data,” for purposes of ascertaining the correctness of any return, making a return if none has been made, determining the tax liability of any person, and collecting that liability. IRS may issue a summons to the taxpayer or certain third parties that it feels may be able to assist in determining the taxpayer’s tax liability.
To have a summons enforced, IRS must make a four-step prima facie showing that: (1) the investigation will be conducted pursuant to a legitimate purpose; (2) the inquiry may be relevant to the purpose; (3) the information sought is not already within IRS’s possession; and (4) the administrative steps required by the Code have been followed.
Generally, meta data is information that describes how, when, and by whom a particular item or set of electronic information was collected, created, accessed, modified, and formatted. Taxpayers may keep their business records electronically with meta data automatically created as an integral part of the records. Often, IRS’s examinations would be advanced by accessing meta data that identifies the original date a transaction was entered in the electronic records, the dates of any changes to the entries, and the username of the person who made the entries. The value inherent in an examiner’s ability to obtain the date and source of recorded entries is self-evident: the information tends to support or undermine the credibility of the entries in the business records.
What information can IRS summon? The CCA looked at several scenarios involving issues related to meta data to determine the reach of IRS’s summons power. It concludes that, while not unlimited, IRS’s power to obtain meta data is indeed broad.
Issue: Can an IRS examiner summon a taxpayer’s original electronic data files to obtain the associated meta data if the taxpayer offers to provide either paper printouts (e.g., spreadsheets) or a truncated or an altered copy of the data files that don’t contain the meta data?
The CCA concluded that as long as the information in the meta data “may be relevant,” to a proper purpose for which the examination is being conducted—such as ascertaining the correctness of the return—IRS may properly summon the taxpayer’s original electronic data files containing the unaltered meta data. The CCA found that it was readily apparent that the phrase “books, papers, records, and other data” in Code Sec. 7602 was more than broad enough to encompass the compelled production of the meta data associated with electronic documents. It was also apparent that meta data associated with a taxpayer’s electronic business records “may be relevant” because the nature of the information contained in the meta data, especially the dates on which the entries were made or modified and the identities of the persons entering the data, may support or undermine the credibility of the records offered to substantiate the accuracy of the return.
In addition, the taxpayer’s offer to provide or actual production of copies that omit the meta data didn’t restrict IRS’s authority to summon the original, unaltered meta data. IRS was entitled to summon the original documents, even though it possessed copies. The original meta data associated with the electronic records could assure the accuracy of the documents reproduced.
Issue: Can an examiner summon the taxpayer’s original electronic data files to obtain the recorded entries and associated, unaltered meta data for transactions that occurred before or after the periods being examined if the taxpayer offers to provide a copy of the data file showing only the recorded entries without the meta data for transactions that occurred during the periods being examined?
The CCA determined that when summoned information dates from a period outside of those being examined, IRS must be prepared to answer the question of why such information may be relevant to the periods being examined. As with any other summoned information, it was enough that the records sought might throw light on the tax inquiry at issue. So long as IRS could demonstrate the potential relevance of the meta data associated with the records, the meta data should be obtainable by summons.
Issue: Can IRS summon the taxpayer’s original electronic data files from the taxpayer’s accountant if the accountant recorded the entries of the business transactions into the electronic file and possesses the records?
The CCA determined that IRS can summon a third-party witness, such as the taxpayer’s accountant, to give testimony or produce information that may be relevant to the examination, including electronic data files and the associated unaltered meta data.
Issue: If a taxpayer provides IRS with an electronic data file on a CD or a thumb drive, must the examiner retain the original CD or thumb drive in the examination case file? Alternatively, may the examiner make an electronic copy of the file and include it in the examination file if the case is closed unagreed and the data file supports the examiner’s conclusions (or the data file contains information that may be relevant to a separate criminal investigation)?
In any case in which a taxpayer voluntarily (i.e., without a court order) provides IRS with an electronic or paper copy of its books and records, the taxpayer can require IRS to return the original copy. Accordingly, the CCA advised that, upon receipt of the CD or thumb drive, the examiner should immediately copy the electronic records for inclusion within the examination file to avoid being forced to prematurely relinquish the only available copy. See Internal Revenue Manual §184.108.40.206(2) (advising examiners to immediately copy records upon receipt). The CCA warned that the only caveats to this approach lie in the restrictions and safeguards codified in Code Sec. 7612(c) for copying any software, including the computer software source code and the executable code.
Issue: Do the Federal Rules of Civil Procedure and the case law under it offer analogous support for summoning electronic records with intact meta data?
The CCA noted that Fed. R. Civ. P. Rule 34(a)-(b) specifically addressed the production of electronically stored information, including meta data. Recent case law supported the proposition that Rule 34 generally requires electronically stored information to be produced in the specified form or forms in which it was requested. If a request does not specify a form for producing electronically stored information, then the information must still be produced in the form or forms in which it was ordinarily maintained or in a reasonably usable form or forms. The case law supported the required production of meta data associated with electronic records, when the specifically requested form included such meta data or when the meta data was necessary for the requested information to be reasonably usable under the circumstances.
QuickBooks 2012 gives us the ability to separate files to reflect only current years, but this issue will continue to be an area of contention in coming years.
If you have any questions regarding this matter or IRS inquires for such data, please do not hesitate to contact us.