IRS Access to QuickBooks Backup Upheld in Federal Court
By Edward R. Jenkins Jr., CPA
On Oct. 28, 2011, District Judge Henry E. Autney of the U.S. District Court for the Eastern District of Missouri found for the IRS in U.S. v. Zerjav, and ordered Frank L. Zerjav Sr., CPA, to produce the electronic QuickBooks backup file of Advantage SourceOne Inc. by Nov. 7, 2011. This column explains why this order is important to CPAs in Pennsylvania, but first it will review the law and provide background on the Zerjav case.
At issue is Internal Revenue Code (IRC) Section 7602, which lays out the basic framework that authorizes the IRS to examine books, papers, records, or other data that is relevant or material to an examination. It also authorizes the use of a summons to obtain information or take testimony under oath from the person liable for the tax due, or any officer, employee, or such other person that has possession of books and records of the business under examination.
Under Section 7602(a), there are four purposes for which the summons authority is granted by Congress:
* Ascertain the correctness of a return
* Make a return where none has been made
* Determine liability for any Internal Revenue tax
* Collect tax liability
IRC Section 7604 codifies the authority of the U.S. District Court to enforce a summons issued under Section 7602.
The ability of the IRS to enforce a summons issued under Section 7602 has been regularly tested in the courts. The line of jurisprudence interpreting Section 7602 has been built since a case on summons enforcement went all the way to the Supreme Court in 1964, U.S. v. Powell (379 U. S. 48). The Powell case established a four-pronged test to enforce a summons under Section 7602:
* The investigation is pursuant and relevant to a legitimate purpose.
* The information is not already in the Commissioner’s possession.
* The Secretary or his delegate has determined that further examination is necessary.
* Other administrative steps required by the IRC have been followed.
Additionally, Section 7602(d)(1) limits the authority of the IRS to issue an administrative summons when a U.S. Department of Justice (DOJ) referral is in effect.
On to the case of Frank L. Zerjav Sr.: Zerjav is a CPA operating in St. Louis who has had run-ins with the IRS over the past few years. First, the IRS accused him, his son, and his company of marketing a variety of fraudulent transactions in 2008. The IRS request for an injunction can be found on the DOJ website.1 The IRS was not granted that request for injunctive relief in 2010 when the DOJ issued a stipulated order in which Zerjav admitted no liability, but agreed to not do anything illegal and to have his practice supervised for a period of five years from the order. You can see the stipulated order that contains the agreement on the DOJ website.2
Though this tangle with the IRS took place half a country away, you should care about Zerjav’s journey through IRS sanctionville. The IRS couldn’t let go of Zerjav, and the result of its ongoing activity could affect you. The IRS continued to pursue Zerjav and his company, Advantage SourceOne Inc. The ongoing battle ended up with the IRS issuing a summons on Jan. 11, 2011, for the QuickBooks backup file for Advantage SourceOne. Zerjav refused, and the IRS went to U.S. District Court to enforce the summons.
This strategy could affect any CPA. The IRS requests QuickBooks backup files as part of its audits of small businesses. In general, each office of the IRS has a QuickBooks license and a designated IRS agent who has received training in the use of the software. In addition to retrieving the information required to support the amounts included on tax returns, the IRS is looking for “badges of fraud” by reviewing the QuickBooks data file, specifically the Audit Trail report.
The broad array of QuickBooks users have different levels of expertise with which they use QuickBooks. CPAs have clearly expressed concern regarding the IRS use of QuickBooks backup files.3
The IRS is adamant that it has the authority to require taxpayers to submit QuickBooks backup files, as it believes electronic backup files constitute “books, papers, records, or other data that is either relevant or material to an examination.” The IRS appears to have a victory with the Oct. 28 court order to enforce the summons against Zerjav.
With the enforcement order in hand, expect the IRS to consider access to the backup file a sanctioned allowance. That may not be so. An examination of the facts of the Zerjav case indicate Zerjav didn’t credibly object. His responses in disputing the summons were construed as “conclusory allegations in opposition to enforcement” by the court.
The issue of whether or not a fraud investigation is within the meaning of Section 7602(a) was resolved in favor of the IRS in the Powell decision. The argument that the IRS had all the necessary information to establish liability in the returns, without the QuickBooks backup file, was not reported in the court order.
The Zerjav case should be intimidating to CPAs. A good read of the IRS request for an injunction against Zerjav, its stipulated order, and the court enforcement order for the QuickBooks backup files is a good idea for CPAs in public practice.
3 See IRS IMRS 11-0001433 for an example of our cautions: http://www.irs.gov/businesses/small/article/0,,id=240654,00.html.
Edward R. Jenkins Jr., CPA, is managing member of Jenkins & Co. LLC in Spring Grove, an instructor of business at Pennsylvania State University, and a member of the Pennsylvania CPA Journal Editorial Board. He can be reached at email@example.com.
LAST UPDATED 2/29/2012