practice economics
If the IRS Asks for Your Records . . .
Buying a new computer system? You need to save the old data.

Pity poor Joe the Ophthalmologist. He just invested in a new computer system, primarily to become HIPAA-compliant, but also to help better manage his growing practice.

When he met with his CPA to go over his and the practice's taxes, the CPA asked what steps the practice was taking to preserve financial records and information from the old computer system in case of an IRS audit or for other purposes. Joe confessed that he had done nothing. In this article, I'll tell you what Joe should have done.

ILLUSTRATION: LIGHTSCAPES PHOTOGRAPHY, INC.

Why Keep Old Records?

First, and probably most importantly, the IRS requires all taxpayers to retain adequate and accurate documentation to substantiate the nature and extent of their income. You can use any reasonable method to store business records manually, such as computer disks, tapes, CD-ROMS or DVDs. If the records are stored on computer files, the practice should print hard copies and retain them.

But how long must you keep such documentation? You need to retain records as long as they may be needed for the administration of any provision of the Internal Revenue Code. This usually means that you must keep records that support an item of practice income for 3 years from the date you file the income tax return on which the income is reported.

However, because there's a special rule that allows the IRS to audit tax returns for 6 years if there's been a substantial (25%) under-reporting of income, you should keep your tax records for at least 6 years from the tax return filing date.

Another reason to keep the financial records and information from the old computer system is if you have to verify practice or physician income for either income division or practice valuation purposes.

What Should A Practice Do?

You need to be able to provide these verifications, which would also be required by the IRS if your practice or its physicians are ever audited. To satisfy the IRS, it's important that you handle your computer system conversion in a way that assures that archived records are available for close scrutiny. This means that, at a minimum, you must do the following as you make the conversion:

• consult your CPA early on before the conversion to verify what information is needed in the event of an IRS audit, and ensure that hard copies of this information are available in your records
• prepare and print out the detailed aging and accounts receivable report as you wind down the one system and commence the new one
• document any actual or potential double counting of income or other revenue and explain how/why it could occur
• save copies of all relevant reports, manuals, state tax reports and personnel records.
  On each of your last few transitional days of running both the old system and the new one:
• perform and verify a back-up
• arrange for records storage in a retrievable format. This may mean paying the software license fee for the old system beyond the last day of its actual use
• print all vital records such as management and medical reports, future schedules, recalls and appointment reminders.

Saving the Old Records

Store all the printed data because you'll eventually stop upgrading the old software that you're phasing out. When you store that information, clearly mark its contents and note the destruction date so you're not paying to keep the (hopefully) outdated or redundant information forever. Keep in mind as you close out your old system that your future access to that software may be very limited.

Remember, planning ahead is key to being able to retrieve the old data you're likely to need or want.

Mark E. Kropiewnicki, J.D., LL.M., is a principal consultant with The Health Care Group, Inc., and a principal and president of Health Care Law Associates, P.C., in Plymouth Meeting, Pa. He regularly advises physicians and practices on their contracting matters and business law obligations. He can be reached at (800) 473-0032.