TEI urges phased implementation of IRS e-filing mandate: December 20, 2005.

On December 20, 2005, TEI sent the following letter to select Treasury officials and the chairs of the congressional tax-writing committees concerning the Internal Revenue Service's mandate to require the electronic filing of large corporate tax returns. The letter was prepared under the aegis of TEFs IRS Administrative Affairs Committee, whose chair is Kelly A. Nall of Electronic Data Systems Corporation.

As the preeminent organization of in-house tax professionals, Tax Executives Institute writes to express concern about the recent Internal Revenue Service mandate requiring large corporations to electronically file their corporate tax returns (beginning in 2005). This mandate, issued last January without proper consultation with affected taxpayers, will impose significant burdens on the business community without any assurance that the IRS will have adequate systems, procedures, and personnel in place to receive and process the data and capabilities to effectively analyze that data to fulfill its audit and compliance responsibilities. The Institute believes the subject is an appropriate one for congressional oversight to ensure there has been a proper balance of taxpayer burden and government benefit.

Let there be no misunderstanding--Tax Executives Institute and its almost 6,000 members support the goal of increasing the IRS's use of technology including its ability to effectively process e-filed returns. Further, we agree that a properly designed and implemented e-filing process will advance key IRS objectives, namely, providing the IRS with accurate and timely return information, reducing audit cycle time, and achieving currency in those audits.

Mandating a laudable goal, however, does not ensure its fair or timely implementation. TEI believes that the IRS's e-filing mandate is ill-advised because it will impose unnecessary costs on taxpayers and may threaten the orderly processing of returns for the 2006 filing season. It flows, we regret to say, from the insular, largely unilateral process employed by the IRS in issuing the mandate, a process that stands in marked contrast to the collaborative, customer-service approach the agency has productively used in other areas (and that is consistent with the goals undergirding the IRS Restructuring and Reform Act of 1998). In this connection, we note that the Internal Revenue Service Advisory Council's recent recommendation to delay the e-filing mandate by one year was rejected by the Commissioner. Finally, we believe that rushed implementation of this mandate without the foundational work necessary at each stage of the return-filing process will increase the risk of duplicated effort and waste of limited resources.

For these reasons, TEI recommends that implementation of the IRS's e-filing mandate be phased in over a series of filing seasons, with the scope and speed of that implementation based on incremental results and actual experience, allowing for accelerated implementation should that be supportable but also permitting moderation, if so required. Congress, in the exercise of its oversight responsibility, should urge the IRS to make the mandate voluntary for filing 2005 corporate income tax returns. (1)

Background

The IRS issued its e-filing mandate on January 11, 2005, promulgating temporary and proposed regulations that mandate the electronic filing of large corporate tax returns for taxable years ending on or after December 31, 2005. For tax year 2005 returns that are due in 2006, the regulations require that corporations with total assets of $50 million or more file their Forms 1120 and 1120S electronically. The electronic filing requirement applies to entities that file at least 250 returns, including income tax, excise tax, information, and employment tax returns during a calendar year. The proposed regulations were accompanied by temporary regulations, which became effective upon their publication in the Federal Register (February 12, 2005).

The e-filing mandate was issued without formal consultation with the constituency that will be most affected--the large corporate taxpayer community. Moreover, the new regulations contained precious little detail concerning how the e-filing mandate was to be accomplished and presumed a level of uniformity and technological sophistication that does not exist, on the part of taxpayers and perhaps also the IRS. Yes, most business taxpayers use computer programs to assist in returns preparation. Preparing the return of a Fortune 500 taxpayer (which could easily exceed 10,000 pages in length), however, is not as easy as sliding a TaxCut or TurboTax disk into its PC. The programs used range from Excel spreadsheets and PDF files, to off-the-shelf programs, to tremendously expensive and complicated customized programs, to a patchwork of self-developed solutions. In these circumstances, converting these disparate pieces into one XML file for e-filing presents very real technical challenges. At the time the regulations were issued, only one major corporate software vendor was authorized to e-file returns, and while other vendors are now "on board," there is no assurance they will be ready.

The approach of the e-filing initiative is markedly different from another recent IRS project, relating to the Schedule M-3 on which a taxpayer reports book-tax differences. With the Schedule M-3, the IRS and Treasury actively sought taxpayer input more than a year in advance and worked to address concerns before a draft of the schedule was issued. And, even after the form was collaboratively developed, the IRS afforded affected taxpayers time to recommend changes and to implement the mandate.

Since January, TEI and other interested parties have worked with the IRS to help make the e-filing mandate a reality. The Institute has met several times with the IRS, and our members and staff have participated in an IRS task group (styled the "IRS-TEI Forms and Attachments Task Group"). This group has held several day-long sessions and numerous conference calls to review every form and schedule a corporate taxpayer may file in an attempt to determine which forms could be filed in XML format and which could be filed in other formats (such as PDF files and on paper). Meetings have also been held with the major software vendors (CorpTax, InSource, and Vertex) in an effort to identify challenges and work toward acceptable solutions.

Unresolved E-Filing Challenges Point to the Need for a Phased Implementation

In spite of the tremendous efforts of IRS, taxpayers, and the software vendors, significant challenges remain--issues that may not be soluble by the time the returns are due to be filed next year. Specifically, one major challenge of the proposal is that many taxpayers use different types of software; a company may, for example, use CorpTax to prepare its domestic schedules and forms and InSource to prepare its international forms. To date, no software exists that would permit data from multiple programs to be aggregated in one XML file, as required by the regulations. This means that taxpayers using different programs are "on their own" in satisfying the mandate.

A second significant challenge concerns recent IRS guidance on securing hardship waivers from the e-filing mandate. Initially taxpayers were promised that the criteria for obtaining a waiver would be issued by September ist. Other priorities (including the need to address tax administration issues spawned by Hurricanes Katrina, Rito, and Wilma) delayed the guidance, which was not issued until November 10th. Although the delay is understandable, it deprived taxpayers of the time and detail needed to determine whether they will come within the mandate and to establish a plan for compliance. Of greater significance is that, even after taking additional time to develop the guidance, the IRS's notice provides taxpayers with little assistance in determining what might or might not qualify a taxpayer for relief. For example, the IRS has indicated on several occasions that companies undergoing mergers and acquisitions may be candidates for relief, but nothing in the notice addresses this issue. Examples of circumstances in which a waiver will be issued are sorely needed (e.g., whether a taxpayer's attempted e-filed return constitutes the "return" for federal income tax purposes; whether a "protective" hardcopy return will protect taxpayers' timely completed but un-filed elections, etc.).

The IRS has also shown precious little sympathy for the financial burden the e-filing mandate would impose on taxpayers, informally suggesting that cost would rarely, if ever, be a basis for a hardship waiver. This is especially disappointing because section 6011(e)(2)(B) of the Internal revenue Code requires the IRS to take into account the ability of taxpayers to comply at reasonable cost with such a mandate.

A third challenge relates to the availability of software from third-party vendors. As of December 2005, no software vendor has released prototypes of the new software that will be used to facilitate e-filing. While historically program and version updates are typically released in December, corporate taxpayers are understandably concerned about integrating the new programs into their existing data collection systems. (2) Given the wholesale changes that have to be incorporated in the new software, taxpayers will be extremely pressed to install, test, and debug the software before their returns must be filed. Further, it is not clear what tools the vendors will provide to allow taxpayers to review data before actual submission.

Finally, even assuming the IRS computer systems are up to the challenge of receiving voluminous electronic data from affected taxpayers on or near the return due date, it is unclear at this stage whether the IRS has devoted the time and resources necessary to develop and have in place the capabilities --both human and technological--to effectively analyze the electronically transmitted tax return information. Stated differently, mandating electronic filing is only half of the equation; the other half is being in possession of the tools and capabilities necessary to effectively utilize that data.

Recommendation

TEI questions whether the software vendors, taxpayers, and even the IRS will be ready for e-filing the entire 2005 corporate income tax return. A too-hasty push to enforce mandatory e-filing could well result in a chaotic and ineffective filing season. A more measured time frame--perhaps requiring the e-filing of only the first four pages of the Form 1120 this year and phasing in the remainder of the forms and schedules over the next few filing seasons--is both prudent and warranted. Under a phased approach, those taxpayers prepared to e-file during this upcoming filing season will do so. For the overwhelming majority still confronting myriad challenges, phasing-in the mandate will facilitate the orderly internal migration and transformation of taxpayer data systems, processes, and procedures and at the same time enable the IRS to fully develop its internal capabilities to analyze the received data. In this way, both IRS and taxpayer objectives will be satisfied.

Conclusion

Tax Executives Institute appreciates this opportunity to present its views on the IRS's initiative to require the mandatory electronic filing of 2005 corporate income tax returns. Any questions about the Institute's views should be directed to either Timothy J. McCormally, TEI's Executive Director, or Eli J. Dicker, the Institute's Chief Tax Counsel. Both individuals may be contacted at 202.638.5601, or [e-mail]; [e-mail].

(1) The process used by the IRS is markedly different from the voluntary approach taken by the Securities and Exchange Commission in respect of transmitting financial disclosure information in an XBRL format.

(2) At least one major vendor has indicated that the e-filing portion of its software will not be available until the end of January.