IRS Will Request QuickBooks (and other electronic) Files During An Audit

“The IRS has initiated a new examination program for small businesses in the past year. This is affecting all examinations of small businesses if they use any electronic accounting software.”

As a QuickBooks^®consultant, I am here to help you understand the issues and assist the small business client in preparing for the examination.

‘The typical [audit] begins with a letter from the IRS advising the business that it is being audited by the IRS. The letter will provide the IRS tax form and the period of the audit. The letter asks the taxpayer to call the IRS to make an appointment for the audit. When the taxpayer or the tax representative calls to get more details, the auditor will ask if the business is using any electronic accounting software. If the answer is “QuickBooks,” then the first IDR (information document request) includes a request of a backup of the QuickBooks data file, and the administrator user name and password to open the file. (Editor’s Note:the IRS implements similar processes for small businesses that use electronic accounting software other than QuickBooks…)

If the QuickBooks data file is provided to the IRS, it is important that it is trimmed to only provide information for the period of the audit. That is generally a calendar year, but for the IRS, the date range should cover 14 months, providing the IRS with the ability to test cutoffs at the year ends.

In 2010, the IRS asked for the QuickBooks files and generally would then produce only the schedules to support the audited items noted in the IDRs. For example, a business may have to provide support for cost of goods sold, travel and contract labor. The IRS would get the QuickBooks data file from the taxpayer, take it back to the IRS office and have a “trained” IRS employee prepare three schedules that could be uploaded into the IRS standard workpapers. That was it.

Since the middle of 2011, the IRS began requesting the data file to do some analytical review. The IRS wants to evaluate the internal control of the small business by reviewing the audit trail report, and look for who made changes to transactions and when. The IRS introduced the concept of looking for “metadata” within the data file, or additional information about the transactions.

A skilled QuickBooks ProAdvisor can prepare Detailed Transaction Reports that includes who the last user was to make a change in the transaction and when the change was made. Such a schedule is the bulk of the information that an Audit Trail Report provides, which is the report that the IRS calls out as a key report for its audit review procedures.

It is important to remember that the acquisition of the QuickBooks data file does not complete the audit. It is only a part of the audit. The taxpayer will still have to provide support in the form of original documents, such as supplier invoices and cancelled checks. Although the IRS states that it is attempting to evaluate internal control for a small business, it is doubtful that there is any material change in the manner in which the IRS will perform an audit engagement. For a small business, it is assumed by many accountants that there is little internal control due to the nature of small business. The owner makes the invoices, deposits cash in the bank and writes out the checks. Where is the internal control?”

If you subscribe to our Monthly Bookkeeping  or Annual “Clean up” services, your electronic file will always be ready with internal controls should you be audited by the IRS.

Source: Intuit Pro Line News Central