Document Retention Rules for Accounting Firms

By the AICPA Tax Practice Improvement Committee Working Group on Document Retention – February 21, 2019
Document Retention Rules for Accounting Firms

Document retention is a topic which has received increased discussion and analysis in the last few years. Articles have been written urging accounting firms to adopt a written retention policy, share it with all firm personnel and inform clients of the retention policy. The discussions and focus of this article are related to tax files and records, and culminate in a sample retention policy and sample schedule of retention periods. Individual state requirements are not considered here. Accounting firms should obtain the necessary counsel to ensure that local and state jurisdiction regulatory requirements are met. Not only should firms consider the state in which they reside, but additionally states where significant clients are located. The sample policy and schedule of retention periods are not to be considered as endorsed documents, but simply as an example prepared by working practitioners to aid you in your efforts to implement or refine your own firm’s policies.

All Documents Must Be Included in the Policy

Historically, paper files were the primary means of documenting our work. Now electronic documents in the form of files, work papers, emails and final work products are maintained in digital format. Today, most offices have a combination of paper and electronic documents. Document retention policies must include all documents, whether paper or electronic, and firms must adhere to these policies in a systematic manner. Whatever the firm’s policy may be, it should be carried out consistently, both in the retention of documents and the discarding of documents no longer required to be kept. When a firm learns that a government agency is conducting an investigation into a client or that private litigation is pending or threatened (even if the firm is not directly involved), the firm should be careful to retain all relevant records, even if they are slated for destruction under the firm’s policy and even if no request has been made for them. Computer users must be aware of the ease with which email, voice mail, and all electronic messages can become public. Even though a firm may regularly purge its email, the people who have received it may keep it forever. No message, whether in writing or electronic, should contain any words or language the sender would not want to read on the front page of the local newspaper or to hear repeated in court.

Internal Revenue Service Requirements

An important part of an overall document retention policy is compliance with Internal Revenue Service requirements, since all taxpayers are required to keep books and records sufficient to establish the amount of gross income, deductions, credits, or other matters required to be shown by the taxpayer in a tax return.1

For federal income tax purposes, books and records are required to be retained so long as the contents may become material in the administration of the tax laws, although “material” is not defined. For practitioners this generally means information relied on in the preparation of the clients' returns. The books and records must be retained, at a minimum, until the expiration of the statute of limitations, including extensions, for each tax year.2

The IRS has issued guidance with respect to computer document retention and electronic document storage, applicable to both business and individual taxpayers whose tax records are computerized or electronically stored.

Computer Document Retention

Published guidance specifies the basic retention and documentation requirements that the IRS considers to be essential in cases where a taxpayer’s books and records are maintained within a computerized system.3 Recommendations for document management and maintenance also are provided. The requirements pertain to all tax matters, including income, excise, employment, and estate and gift taxes, as well as employee plans and exempt organizations.

Although applicable specifically to taxpayers with assets of $10 million or more and other taxpayers who maintain computerized records not available in hardcopy, much of the computer document retention guidance addresses business taxpayers. The IRS routinely reminds business taxpayers of their responsibilities for computer document retention at the beginning of an audit.4

The taxpayer must maintain and make available to the IRS, upon request, documentation of the processes that:

  • create the retained books and records;
  • modify and maintain the books and records;
  • provide sufficient information to support and verify entries made on the taxpayer’s return and to determine the correct tax liability; and
  • evidence the authenticity and integrity of the taxpayer’s books and records.

The taxpayer must provide, at the time of an examination, the resources that the IRS determines are necessary to process the taxpayer’s computer books and records.

Electronic Document Storage

The IRS has provided guidance on the maintenance of books and records on an electronic storage system that either images hardcopy or transfers computerized books and records to electronic storage media.5 Books and records maintained in an electronic storage system that complies with the IRS requirements will constitute books and records as required by the tax law and regulations.

The general requirements are that an electronic storage system must:

  • ensure an accurate and complete transfer, indexation, storage, preservation, retrieval and reproduction of the hardcopy or computerized books and records;
  • include reasonable controls, and an inspection and quality assurance program to ensure the integrity, accuracy, reliability, and security of the system;
  • provide the ability to reproduce legible and readable hardcopies; and
  • provide support for the taxpayer’s books and records.

The taxpayer must provide, at the time of an examination, the resources that the IRS determines are necessary to process the taxpayer’s computer books and records. Destruction of hardcopy books and records and deletion of original computerized records are permitted after testing of the system is completed and procedures are implemented to ensure compliance with IRS guidance. In any case, books and records must be retained, at a minimum, until the expiration of the statute of limitations, including extensions, for each tax year.

Sample Document Retention Policy

Information is an important asset of our firm. These policies apply uniformly to documents retained in either paper or electronic format. Our policy pertaining to the retention and destruction of email documents mirrors the policy for documents in other electronic or paper formats.

Documents to be retained

We will retain firm business records to comply with Internal Revenue Service requirements. In relation to the professional services we provide, our policy is to retain documentation necessary to support our work (including opinions, resolution of differences, conclusions and research utilized in analysis), our correspondence with clients, our work product and items of continuing significance. Drafts or other documents not utilized should not be retained. Documents transmitted as attachments via email should be considered separately from the email messages to which they are attached. Original client records will be returned to clients and will not be a part of our ongoing files.

Procedures for document storage

(Each firm should explain its procedure for document storage. Several general guidelines should be followed to ensure that files are properly stored for easy retrieval and that client information is safeguarded. All client service information must be stored in the firm’s central system.)

Documents attached to and transmitted by email should be stored in machine readable format in the firm’s electronic document management system in the appropriate client folders. Those email messages which actually contain information pertinent to the completion of a tax return or financial statement, such as a client’s responses to a list of questions, should be copied in PDF or other machine readable format and included in the source documents folder. Email messages not saved for filing in the correspondence file or other appropriate folder should be deleted. (The firm should also address the retention period for emails retained on email servers.)

Retention Periods Firm Records

  • Accounting records
    • Annual general ledger detail — 7 years
    • Annual financial reports — 7 years
    • Bank statements & cancelled checks — 7 years
    • Depreciation schedules — 7 years
    • Employee expense reports — 7 years
    • Equipment records & invoices — 5 years (after disp)
    • Monthly financial reports — 7 years
    • Payroll files and related reports — 7 years
    • Vendors’ invoices & paid bills — 7 years
    • W-2 or 1099 forms — 7 years
  • Administrative records
    • Accident reports and claims (after an accident or settlement) — 7 years (after)
  • CPE records — 7 years (after term)
  • Client newsletters & alerts — 7 years
  • Corporate documents, agreements, annual reports, minutes, bylaws — Permanent
  • Firm publications & promotional brochures — 7 years
  • Insurance documents & policies — 7 years (after term)
  • Leases and contracts — 7 years (after term)
  • Personnel files (post-employment) — 7 years (after term)
  • Retirement plan (401 (k) plan info) — Permanent
  • Tax returns — Permanent
  • Work sheets and related backup documents for tax returns — 7 years
  • Time & charges information
    • Client billing statements — 7 years
    • Employee time sheets — 7 years
    • Direct charges sheets — 7 years
    • Accounts receivable reports — 7 years
    • Work in progress reports — 7 years
  • Tax exemption documents, including application for exemptions — Permanent
  • Shareholder documents, agreements & contracts — Permanent

Retention Periods for Client Records

  • Annual financial statements
    • Current clients — 7 years
    • Former clients — 7 years
  • Audit reports
    • Current clients — 7 years
    • Former clients — 7 years
  • Bookkeeping and payroll files — 7 years
  • Compiled or reviewed monthly and quarterly financial statements — 7 years
  • Forecasts & projections — 7 years
  • Litigation support files — 3 years
  • Pencil drafts
    • Financial statement reports — Destroy immediately
    • Tax returns — Destroy immediately
  • Permanent files
    • Current clients — Permanent
    • Former clients — 7 years
  • Reports with government agencies
    • Current clients — 7 years
    • Former clients — 7 years
  • Special reports — 7 years
  • Tax returns
    • Current clients — 7 years
    • Former clients — 7 years
  • IRS audit files
    • Current clients — 7 years
    • Former clients — 7 years
  • Work paper files - current clients
    • Audit — 7 years
    • Comp. & review — 7 years
    • Tax — 7 years
    • Estate & gift tax — Permanent
    • Special reports — 7 years
    • Forecasts & projections — 7 years
    • Valuations — 7 years
    • Audit & review backup — 7 years
  • Work paper files - former clients
    • Audit — 7 years
    • Comp. & review — 7 years
    • Tax — 7 years
    • Special reports — 7 years
    • Forecasts & projections — 7 years
    • Valuations — 7 years
    • Audit & review backup — 7 years

All clients should be notified in writing that the Firm’s policy is to destroy files, and that they may request copies of any data contained therein subject to Firm approval.

Retention periods commence immediately following the date of the financial statements or the taxable year in the case of tax returns and work papers.

Destruction and Control

Destruction of documents is as important as their storage. Paper documents which are not to be retained in the firm’s files must be shredded or incinerated if they contain confidential information or sensitive data. Any paper with a social security number, a federal ID number or a client name on it must be destroyed in this manner; never just dropped in the trash. Electronic documents are destroyed by deleting them from the medium on which they are stored, and then purging the medium itself. A written list of files (both paper and electronic) to be destroyed will be reviewed by each partner for clients with potential issues that may require a longer retention period. Any exceptions to the above retention policies must be approved by the Engagement Partner in writing on a document retention exception log and approved by the Managing Partner. (See Exhibit A for a document retention exception log form.) Exceptions should be very limited and the reason should be clearly documented.

A list of files destroyed will be maintained permanently. If we learn that a government agency is conducting an investigation into a client or that private litigation is pending or threatened (even if the firm is not directly involved), we will retain all relevant records, even if they are slated for destruction under the firm’s policy and even if no request has been made for them.

[Firm Name] Document Retention Exception Log

Date ________________

CLIENT NAME DESCRIPTION OF DOCUMENTS AND REASON NOT DESTROYED












_______________________________________
Engagement Partner

_______________________________________
Managing Partner

Note: The purpose of this form is to document exceptions to the [Firm name] document retention policy. The exceptions should be very limited and the reason should be clearly documented.


This article was prepared by the AICPA Tax Practice Improvement Committee Working Group on Document Retention:

  • Barbara A. Ley, Chair
  • Mark Sellner
  • Howard Herman
  • Valda S. Rispoli

Special thanks to the firm of Porter, Muirhead, Cornia & Howard

1 Regs. Sec. 1.6001-1(a)
2 Rev. Proc. 98-25, Section 5.01
3 Rev. Proc. 98-25
4 Form 4564, Information Document Request, issued by an IRS Computer Audit