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The IRS wants to usher in the era of E-filing, but going paperless won't be easy.
Craig Schneider, CFO Magazine
November 1, 2005
This past January, when officials at the Internal Revenue Service announced they wanted many corporations to begin filing their returns electronically for the 2005 tax year, critics howled. After all, few companies appeared ready to go smokeless. In 2004 — when businesses were allowed to voluntarily file their tax returns electronically — only 332 companies (with assets of $10 million or more) did. Even Deborah Nolan, IRS commissioner for the Large and Mid Size Business Division, says the prospect of electronic filing has caused "a lot of angst."
Filers will just have to get over it. The IRS appears committed to a paperless system — and with good reason. The dark, mysterious labyrinth known as the U.S. tax code generates enough paperwork each year to bury entire civilizations. In some cases, the forms from just one corporation fill an entire tractor trailer. Given the avalanche of paper, it's not surprising that it takes the understaffed agency anywhere from 14 months to two years to sift through all incoming corporate tax returns and make them available to field agents for auditing. Nolan says E-filing will help the IRS to reduce the time frame to 90–120 days.
That's a heck of a time-saver. What's more, paperless filing should make it easier for IRS agents to conduct risk assessments and better allocate enforcement resources. It will also likely help the agency quickly identify corporate taxpayers that warrant an audit — not exactly swell news for the 11,000 businesses that will be affected by the new rule in 2006.
Most of those companies (outfits with assets of $50 million or more that also file at least 250 returns a year) have until September 15 to make the switch to Internet filing. Experts say the looming deadline places a great deal of pressure on corporate tax departments — and the IT workers who support them. Typically, a return is prepared using multiple programs and platforms. The new regulation requires that an entire return be created on a single platform. IT departments must now figure out how to make this happen. The worry? According to Stephen R. Buschel, tax partner with BDO Seidman LLP, a rejected E-file transmission could cause a company to miss a filing deadline and therefore be at risk for penalties. Although guidance for this issue may yet be forthcoming from the agency, Buschel says: "I think the IRS is still struggling with that."
Filers will no doubt be glad to know they're not the only ones struggling with the mandate. One early problem: large companies often use one kind of tax-preparation software for the financial portion of their tax returns and other programs such as Microsoft Word or Excel to add information for elections, contracts, or appraisals. Initially, the IRS indicated it would only accept electronic returns using the same extensible markup language (XML) format that the agency uses in its internal E-file system.
After holding discussions with various groups (including Tax Executives International), the agency eventually softened its stance on file formats. While an entire tax-year return must be submitted as one file, businesses will be allowed to attach some supporting data as PDF documents. Officials at the IRS also decided to permit companies that file at least 25 agency-specified international forms to use paper — as long as the company also submits a summary in XML. Likewise, the IRS agreed that in the first year of compliance it would accept summary totals for transactional data such as depreciation.
Get Well Soon?
Tax experts say time-sensitive elections are at the core of many of these E-filing worries. Tom Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants, points out that most elections for certain tax treatments — things like research credits or changes of accounting methods — are voided if they are not accepted within a timely filed return. "In general, if you miss a filing deadline, you can't change the accounting method or make the initial election to consolidate your entities," explains Ochsenschlager. Given this dilemma, he anticipates that the IRS "will show flexibility, at least for the first year of the mandatory E-filing program, regarding what it deems a 'timely filed return.'"
Of course, flexibility is not exactly a hallmark of the IRS. Nevertheless, Nolan insists the agency will be "reasonable in its approach." She notes that the IRS plans to work with taxpayers on a "get-well" plan, assuming, that is, that the filers have made a good-faith effort to transmit returns. In such cases, she says the IRS has extended its cure period to 20 days to allow companies to resubmit their returns electronically.
Why all the concessions? Enlightened self-interest. The IRS wants to lower the number of companies that qualify for hardship waivers. The fewer waiver requests, the fewer reviews the agency has to conduct. At press time, the IRS had yet to publicly post the qualifications for hardship. But Nolan says mitigating factors could include a year-end merger or acquisition, an IT system failure, or a natural disaster.
But "busy with other stuff" probably won't cut it, and that could be a problem. As Thomas Wilson, a managing director of the Washington National Tax Service, IRS Service Team, at PricewaterhouseCoopers LLP, points out, many finance managers have been so busy with their 2004 corporate returns that they haven't spent much time focusing on E-filing.
Indeed, tax managers have had all they can handle just coping with other mandates from the IRS. Dawn Beatty, senior manager of the National Tax Process Group at Grant Thornton LLP, says the tax environment is constantly changing, making it difficult for companies to keep up. For example, many companies have been focused on culling data for a more complex Schedule M-3. That schedule calls for reconciliation between a company's financial income statement and its tax returns for various items. For finance managers at some of those businesses, E-filing has been the least of their concerns. Says Michael Dolan, director of IRS policies and dispute resolution in the Washington National Tax Group of KPMG LLP: "There are people who have been wrestling with how to get the data into the M-3, regardless of paper or electronic [filing]."
The IRS has provided some relief, giving companies the option to file a minimal portion of the Schedule M-3 as part of their electronic filing in the first year. But even if filers manage to meet the E-filing deadline in September, they can expect more complications down the road as states piggyback on the federal government's E-file initiative. Currently, Massachusetts requires businesses to E-file their income tax returns, and four other states allow voluntary E-filing.
Reportedly, the IRS is working with the Federation of Tax Administrators and 26 state tax agencies on a joint project to develop a new federal/state E-filing system. "Each state has its own intricacies on how to file [electronically]," says Robert A. Mathers, national director of tax services at Clifton Gunderson LLP. "It's an increasing burden for any accounting firm that has multistate returns for companies."
In the meantime, here's one other potential complication to ponder: while the IRS says otherwise, it's no dead certain lock that the agency's computer network will be able to seamlessly process 11,000 electronic tax forms come September 15. If it can't, officials at the agency may want to consider applying for one of its own hardship waivers.
Craig Schneider writes frequently about accounting and tax issues.
Paperwork Reduction Act?
The IRS plan for E-filing
Corporations with assets of at least $50 million and 250 or more returns each year (total includes income tax, information returns, excise tax, and employment tax returns).
Internet submission of corporate tax returns (1120 and 1120S). Each form included in a return should be attached as a separate PDF file. The total tax return cannot be larger than 1 gigabyte (5,000 PDF pages), and no individual attachment may exceed 50 megabytes (500 pages).
Due September 15, 2006 (for tax period ending on or after December 31, 2005).
The IRS has been working with the Federation of Tax Administrators and 26 states on a joint project to develop a new federal/state electronic filing system. Currently, only Massachusetts requires E-filing; more are expected to follow suit.
Source: Internal Revenue Service