Expanding into cyberspace.

A booming market in transition.

Get ready, tax accountants, practically every aspect of the tax preparation field is changing. In fact, it's evolving into a totally new market and business. First of all, the number of tax software brands is shrinking, leaving thousands of CPAs tax software orphans with fewer replacement products to choose from. And while the number of brands declines, the market expands into cyberspace as, slowly but surely, accountants begin to abandon their annual ritual of loading the latest tax CDs onto their computers. Instead, they're logging onto Web sites and preparing taxes online. And despite nearly unanimous earlier forecasts that the business of tax preparation was static--if not declining--tax CPAs are busier than ever processing returns and providing guidance.

Let's look at these developments to see how they affect professional tax preparers and the dwindling number of software vendors.

THE SHAKEOUT CONTINUES

Ten years ago, there were more than 100 tax preparation software products. That number has since shrunk to about 40--a result of acquisitions and product dropouts caused by the intense competition and vendors' inability to keep up with technological advances. Although some industry observers think the worst part of the industry shakeout is over, others expect the shrinkage to continue a few more years until less than a dozen tax vendors survive.

Those vendors that have endured the market consolidation have learned that only three marketing strategies appear to succeed in this high-tech, fast-moving, keenly competitive environment: consolidate, innovate, slash prices. Survivors have used one or all of the strategies: buying up the weaker stragglers for their customer lists, inventing ways to make their software stand out from the ever-dwindling crowd of competitors and offering first-time customers large discounts.

Price-pruning, while always a costly last-ditch strategy, has become even more expensive now. In the past, customer turnover was relatively low because changing software products was such an expensive and time-consuming headache: Not only did CPAs have to go though what was often a painful process of loading the new programs, but then they had to learn how to use them and convert all their client records. Today's tax software generally is easier to install and the conversion process is mostly automated and very accurate. In addition, many of today's products come with powerful interactive training features, so the learning curve is much briefer, less painful and more successful.

Thus new customers don't feel as locked into a product as they did in the recent past; as a result, a deep discount for a first-time customer who becomes dissatisfied and subsequently switches has turned into an especially expensive loss-lead.

In addition, today's customers are more demanding: They have grown to expect each annual software update to be faster and include more states, forms and schedules. They also expect the software to be easier to run and learn, so that new users will be able to crank out tax returns with little or no training.

The more financially and technologically resourceful vendors know that getting beyond mere survival in this market environment requires more than just consolidation, innovation or discounting; they have to offer all three. And that's exactly what some of them are doing.

For the tens of thousands of professional tax preparers, this is both good news and bad. The good news is that they are benefiting from the results of the heavy investments in product improvements, including the addition of more auxiliary functions, such as tax planning, automatic client invoicing and seamless integration with write-up software and electronic tax organizers. But the bad news--being cast into the role of software orphan--has become less traumatic because switching to a new product is now easier.

PRICE PICTURE

Since the cost of today's technology--both hardware and software--is shrinking, one would expect tax software prices to shrink, too. However, posted prices of many professional tax packages are showing increases from last year.

How real are these price increases? To be sure, aggressive vendors--and most of today's vendors are quite aggressive--offer substantial initial discounts to get a user of a competing product to cross over. In addition, many vendors quietly offer other discounts, especially if a customer is large or is resisting renewing. Just as no two airline passengers on any given flight pay the same fare, so, it's claimed, no two tax software customers of the same vendor pay the same price either.

Most vendors flatly deny such practices. The official word is: The price on the package is the price paid. Some, however, reluctantly--and privately--concede that price discounts are widespread, while others says discounting occurs on a limited scale. More important, they insist that there is less discounting this year than in prior years because software sales are so strong.

In part, of course, vendors are picking up more sales because the competition has thinned out. But growth is coming from other quarters, too. Many vendors say the tax preparation business is now a bull market because more individuals are turning to professional preparers even though they're being courted by low- or even no-cost tax-prep deals on the Internet from, among others, financial firms seeking to lasso new brokerage or banking business.

What's behind the surge in tax-prep growth?

It can be attributed largely to strength and volatility of the stock market and the maturing of Baby Boomers.

Since more people are in the stock market than ever before, and since the market is both bullish and volatile, many investors no longer feel competent (or have the time and interest) to prepare their own returns. Indeed, at their new economic station many find the process too complex and the risk of mistakes and missed tax-saving opportunities too great. Another magnet drawing new customers to professional tax preparers: the growing complexity of preparing for retirement.

TAXES IN CYBERSPACE

Professional tax preparation in cyberspace--that is, doing taxes online--while growing steadily, is still more talk than action.

The two restraints on online growth are limited availability of high-speed Internet links and accountants' concerns about security. Both obstacles are beginning to crumble. High-capacity communications--from cable to dedicated communication lines to direct satellite links--are not only becoming widespread but competition among carriers is shrinking tariffs. And although CPAs remain somewhat cautious about exposing clients' confidential tax data on the Internet and, worse, storing them in the tax software vendor's host computer, even those barriers are weakening as vendors address these concerns with superhigh security measures.

In addition, professional tax preparers are discovering the benefits of warehousing the data on the vendors' giant computers: Not only is the information safer and more accessible, but, because of its location and format--as a large, integrated database in one place--research results can be applied to it quickly, conveniently and accurately. For example, if research turns up a new tax law interpretation, a CPA can quickly and easily locate the affected returns and make the necessary adjustments.

Another convenience is-the potential to use the database as a marketing tool for selectively offering clients expanded financial services.

The pioneer in the cybertax field, RIA, says that in 1998, when it launched the Go System service in addition to providing its program on CDs, it handled some 76,000 returns online. Last year, volume soared to 197,400 and this year RIA anticipates a total of 273,000. While that's still miniscule compared with the millions of returns prepared by CPAs, every major--and minor--tax software vendor has cybertax on its radar screen. This year, for example, CCH Computax will launch its online test product, called Globalfx.

The concept--applying the application service provider, or ASP model--has been around for a few years, but only now with the growing acceptance of the Internet and the increasing availability of fast communications is it taking root. This year a handful of ASP services have been launched--including office suites and even full-service accounting. Users at a simple workstation can connect via the Internet to the ASP's remote computer, which contains not just the entire application (be it accounting or word processing) but even a data warehouse where users store their information. As a result, users can get to their data from any computer with Internet access. All they need is a password.

The business of tax preparation in cyberspace still requires more aging. For example, will it be a fee service? Most tax professionals will probably not gamble on a free service that makes its money by splashing banner ads on user screens. Will the fee be a flat charge for access to the application and data warehouse or will a user be charged for each return? How will the providers charge for auxiliary research functions--by the hour, task or with an annual fee?

Likewise, there are technological questions. Will the service use what's called a thin-client model to speed the operation? In that model a small portion of the tax software is installed on the user's computer and the rest runs on the host's remote server so that all the heavy calculations are accomplished remotely. Or will the ASP service use a Citrix model--a technology in which the entire program runs remotely and only the display is conveyed to users' workstations, which can be no more powerful than decade-old 286 computers?

As a practical matter, CPAs could care less about the technology choice. In fact, the goal of cyberspace tax preparation is to require accountants to do nothing more than prepare taxes; all the technology--from loading the software to tweaking the format to fixing bugs--will be handled remotely by the tax service on its host computer.

THE FUTURE

Meanwhile, many change-weary CPAs are asking, What next? What can we expect after online tax preparation?

While we won't see it next year or maybe even the year after, the next step is sure to be voice-activated tax software. Assuming the background financial information will be stored in some central data warehouse, taxpayers' pocket computers will be linked via the Web to their banks, employer paycheck services, brokers and any other tax-related resource to gather essential information. Miscellaneous data, such as business travel expenses, will be spoken into the computer and at yearend all that assembled data will be XML-formatted for the tax software and transmitted to the accountant for analysis and final preparation.

The accountant, by the way, will not need to be in his or her office to analyze the tax data or prepare the return. Since all the pertinent client information will be stored in the remote computer, the accountant could be spending the arduous weeks before April 15 on a beach in Jamaica with an Internet-connected laptop, calling up any necessary information by speaking to the computer, which will recognize either clients' voice prints/face or iris images for security. And since the tax return can now be signed and filed electronically, not even a printer would be necessary. Finally, the bill for the tax service would be transmitted by e-mail and paid by credit card by return receipt.

Are you ready?

A snapshot of recent major tax software acquisitions

1997 RIA buys Creative Solutions.

1998 RIA buys CLR.

1998 CCH buys Pencil--then terminates support.

1998 Intuit buys Lacerte.

1999 Intuit buys TaxByte, then terminates support.

2000 CCH buys A*Plus*Tax from Arthur Andersen.

Yes, DOS Still Lives

For years, software pundits have predicted the death of DOS, and each year they have been proven wrong. Ironically, while all these high-tech changes are under way, it's estimated that between 5% and 15% of CPAs still use DOS tax software programs to prepare clients' taxes. They continue to ignore Windows products--the graphical interface--and stick with the simple, reliable and fast DOS software. While it can't do all the fancy steps that Windows products can, it nearly never crashes and speeds along faster than Windows.

EXECUTIVE SUMMARY

* PRACTICALLY EVERY ASPECT OF THE tax preparation field is changing evolving into a totally, new market and business. The number of tax software brands on the market is shrinking, leaving thousands of CPAs tax software orphans with fewer replacement products to choose from.

* WHILE THE NUMBER OF BRANDS declines, the market expands into cyberspace and, slowly but surely, accountants are beginning to abandon their annual ritual of loading the latest tax CDs onto their computers. Instead, they're logging onto a Web site and preparing taxes online.

* DESPITE NEARLY UNANIMOUS EARLIER forecasts that the business of tax preparation was static--if not declining--tax CPAs are busier than ever processing returns and providing guidance.

* SINCE THE COST OF TODAY'S TECHNOLOGY--both hardware and software--is shrinking, one would expect prices of tax software to shrink, too. However, posted prices of many professional tax packages are showing increases from last year.

* PROFESSIONAL TAX PREPARERS ARE DISCOVERING the benefits of warehousing the data on the vendors' giant computers: Not only is the information safer and more accessible, but, because of its location and format--as a large, integrated database in one place--research results can be applied to it quickly, conveniently and accurately.

* WHAT TECHNOLOGICAL ADVANCES CAN WE expect after online tax preparation? While we won't see it next year or maybe even the year after, the next step is sure to be voice-activated tax software.

STANLEY ZAROWIN is a senior editor on the JofA. Mr. Zarowin is an employee of the American Institute of CPAs and his views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.