Brave new e-filing world: ready or not, it's here to stay.

In 2002, Noelle Allen and her client plunged into the e-file world. The Cameron Park-based CPA reflects that going from "zero to a hundred" in a single filing season was an administrative challenge that resulted in changes to her office procedures. But, she adds, the biggest change wasn't tangible. "The No. 1 thing e-filing involved was a change in my attitude," she says. "Once you make up your mind to do it, you realize the change isn't that drastic--and you find that you've ended up with a much cleaner setup."

That attitude will go a long way now that California's recently passed budget made e-filing mandatory for all practitioners who file 100 or more individual state tax returns per year and use tax preparation software. Prior year, fiduciary and amended returns are not required to be e-filed, and California doesn't offer the option of e-filing business returns.

The Franchise Tax Board predicts that the move will reduce the state's annual tax filing costs by $50 million, and anticipates more than two million additional e-file returns next year.

The requirement takes effect Jan. 1, 2004---and the FTB will go after those not following the rules. There will be a $50 penalty for every return filed on paper that could've been done electronically.

THE FIRST DAYS ARE THE HARDEST

Allen concedes that the transition to e-filing comes with some growing pains, especially during the first year as office procedures must adapt to the new processes and procedures.

"The first year of doing this is more labor intensive than successive years, because you have to input a lot more data than you had to before," Allen says.

For example, a practitioner must input W2 and 1099 information, including federal and state employee identification numbers, which takes extra time.

But once those details are complete, the benefits become apparent, says Tina Stiles, an e-Programs specialist with the FTB.

"Once you have that data, if you continue with the same software, it just updates the taxpayer's personal information from the year before," she says. "So from then on, it gets easier and easier."

This additional level of detail, however, doesn't thrill everybody. Ken Fowler, CPA and co-chair of the Taxation Committee for the Silicon Valley San Jose Chapter, believes that if practitioners are required to e-file, everyone should follow suit.

"What I'd rather have is the taxpayer bringing us an electronic file of their income," he says. "I don't want to be a data entry person my whole life."

That way, Fowler says, he can transfer that information into his electronic files, prepare and verify the returns, and file electronically.

To accomplish this, Fowler believes the next step in the evolution of e-filing is to require information such as W2 forms, bank statements and broker statement be made available to taxpayers electronically.

PREPARE YOURSELF

Along with all the added effort to get office procedures up to speed with e-filing comes added expenses.

Some practitioners will have to purchase e-filing software--which vary in cost from hundreds of dollars to thousands of dollars depending on the features included, others will need to update existing software packages.

But even those updates don't come cheap.

Mary Kay Foss, a Danville-based CPA and chair of the CalCPA Committee on Taxation, says her office just received a bill for $1,200 from their software provider to upgrade her office's software for e-filing. "That's kind of hard for a small firm like ours," she says.

Foss also says e-filing will mean some shifting in job responsibilities at her firm. For example, when a paper return is finished and mailed to a client, ideally that client reviews the return, signs it and mails it back.

Under e-filing, however, the client must sign and return a California e-file Return Authorization form before that file can be sent to the FTB--a detail that not every client may follow faithfully.

"We're going to need to assign somebody the duty of following up and making sure clients sign and send the forms back to us," Foss says.

There also will be a more involved administrative function in tracking the status of each return, says Dan Crosbie, a Sacramento-based CPA, who also is chair of the Committee on Taxation's State Tax Subcommittee and a member of the FTB's advisory board.

"You'll have to track the status of the return in your office, whether clients have authorized their review, whether it has been accepted or rejected by the government," he says. "It adds steps, not just in the tax preparation functions, but in the administrative aspects as well.

"We've been asked to take on additional expense, additional time and effort, and effectively become the transfer agent in filing returns," Crosbie says. "But on the plus side, the accuracy of returns will be improved."

Crosbie adds that the additional costs of transitioning an office to e-filing may be offset by the reduction in paper, printing and copying costs, as well as the reduced wear-and-tear on office equipment.

WHY E-FILE?

Improved accuracy, greater security and faster refunds are just a few of the benefits associated with e-filing.

"When a tax return is mailed to the IRS, there are at least eight people that will handle that return," says Maria Jaramillo, a tax specialist with the small business, self-employed taxpayer communication division of the IRS. "There's a lot of opportunity for error in the process."

Last year, errors were found in roughly two of every 10 paper returns, but the rate for e-filed returns was less than one percent, according to Jaramillo.

Some of those errors could be attributed to the tax prepare, but Jaramillo says internal processing mistakes constituted the lion's share of errors.

But once the return is e-filed, "within 48 hours, you'll receive an acknowledgement from your software company or the FTB as to whether you're return has been accepted or rejected," says Dwayne Thomas, an e-file liaison in the FTB's outreach and communication division.

And as far as security goes, "I can't stress enough that if there is any kind of identity theft, it would happen on a paper return," says the FTB's Stiles, because there is a greater number of people handling paper returns than an e-filed return, which is only seen by your client, you and the FTB's computer.

To reap the benefits of e-filing, a practitioner must be committed to it, Allen says.

"I've heard practitioners say they're going to try five or 10 (returns) first, and see how it goes," she says. "But then you're running two office procedures, and any time you add complexity to this process there's the possibility of errors."

OPTING OUT

But what if your client doesn't want to file electronically? Not to worry.

The FTB is developing an opt-out form that should soon be included on its website (www.irs.gov). The form will give preparers a chance to state a reasonable cause for not e-filing. Reasonable cause includes, but isn't limited to, a taxpayer's election not to e-file. The reasonable causes will be reviewed on a case-by-case basis.

"There are going to be some instances when you can't e-file a specific form. There are about five forms we don't accept electronically," the FTB's Stiles says. "And you may have multiple returns for different states, and your software doesn't allow you to e-file them all. We understand that."

But opting out should be the exception, not the rule, she says.

CALCPA REFINES E-FILING

The current e-file requirements have been a work in progress over the past year and a reflection of the efforts of CalCPA's Committee on Taxation to defeat the initial proposal.

When the mandatory e-file proposal was first introduced in last year's budget, it did not include:

* an opt-out provision for clients or tax practitioners;

* a provision to protect those who do not use a computer and tax preparation software;

* provisions for those who were rejected by the IRS' e-filing program; and

* an exemption for business returns, especially given the fact that many business filings could not be electronically filed.

After some work by CalCPAs Committee on Taxation, the above issues were addressed in the current e-file process. [CPA]

Jerry Ascierto is CalCPA's associate editor. You can reach him at [e-mail].

HOW TO e-file The Process

To get the e-filing process started, you'll first need register with the IRS electronic filing service to receive an electronic filing identification number (EFIN). Then you may register with the FTB's e-filing program. Simply fill out Form 8633, Application to Participate in the IRS e-file Program.

Information on forms and registration can be found at www.irs.gov/efile/article/0,,id=98344,00.html.

Following a background and suitability check, approval is generally granted within 45 days. Though denials are rare, the IRS says, there are circumstances when approval is not granted, such as whether the background check yields a report from the FBI, if you owe money to the IRS or if you haven't filed all of your taxes.

In the event that you are rejected, the IRS will notify you in writing as to why. You then have 30 days to appeal in writing and the IRS will review the case.

Even if you are denied, you may file paper returns.

According to the FTB, retain the initial rejection letter in your files in case it asks why you're not e-filing. You are not required to notify the FTB up front of your inability to join the program, however.

ON TO E-FILING

The process begins by preparing your clients' return as you normally would, and providing them with a copy of their return and a California e-file Return Authorization, or form FTB 8453. Once the client signs and returns the authorization form, you're ready to file.

After e-filing, an acknowledgement (ACK) file will be returned to you within 48 hours, which will let you know whether the return was accepted or rejected due to errors, the FTB says.

If an error is found, the ACK file will identify the error (including error codes), the form or schedule where the error was found and the number of occurrences (for multi-page forms and schedules).

Once the errors are corrected and the return is resubmitted, record the date of the accepted ACK on the corresponding FTB 8453 form. You must retain that form for four years from the return due date or the filing date, whichever is later, the FTB says.