Tax software hits the Net.

Professional tax preparers, fasten your seatbelts. CPAs, already buffeted by wrenching acquisitions that have left many of them software orphans, now face a new technological challenge: the Internet. Tax software vendors must meet the challenge or face possible extinction.

This tax year, at least one vendor--RIA--will put its complete GoSystem Tax software product on its own remote servers, and tax preparers will have the option of doing their clients' returns remotely via direct highspeed communication links or the Internet rather than have the tax software run on their own systems. Both the tax software and the clients' data will reside on RIA's remote computers. At least one other vendor also expects to be online this year, and next year--if these forays into online service make money--competitors surely will follow.

Setting up computer banks for high-speed servers and communication hardware is not cheap, and because smaller vendors will be hard put to finance such a venture, it seems likely that the wave of consolidation that has shrunk the industry for nearly a decade will accelerate.

BACK TO THE FUTURE

The move to online tax prep creates a certain back-to-the-future irony by echoing a process popular from the 1960s to 1980s. That was when most professional tax preparers not only didn't have tax-preparation software, but many didn't even have computers. Instead, they sent their clients' tax data to service bureaus, where mainframe computers calculated clients' returns. The new online system will be the 21st-century equivalent of the service bureaus of yesteryear.

From the tax preparers' vantage point, little will appear different. Their computer screens will look as they do when the tax software is loaded on their own systems. The only difference will be that clients' tax data, although keystroked into the preparer's computer, will now be transmitted to the vendor's remote computer, calculated and then zipped back to the CPA's workstation for printing the finished return. According to RIA, the data roundtrip will be so fast it will seem as if the software is running locally.

Online tax service isn't new--but it is new for professional tax preparers. Last year, individual taxpayers who prepared their own returns had access to two Internet-based online services: OneTax (www.onetax.com) and Universal Tax System (www.securetax.com). And this year Intuit will introduce WebTurboTax (www.web turbotax.com).

It's not clear how such online services for the nonprofessional will affect the business of professional preparers. Forrester Research, the technology market research firm, predicts that some 250,000 taxpayers will do their returns online next year. And within three years, the consulting firm expects that number to exceed the number of individuals who prepare their own taxes by loading tax software on their computers--either by plugging floppy disks or CDs into their computers or by downloading the files from the Internet.

FINANCIAL ADVANTAGE

What makes online tax preparation so attractive to both vendors and users?

From the software vendors' point of view, there are financial advantages to centralized service. Aside from their investment in new hardware (computer servers and communication gear)--which admittedly is an expensive initial outlay--it hardly costs them much more to provide the service to one customer than it does to provide it to 1,000 or even a million. Once the tax application is loaded on the servers, any number of users can access it. The power of the servers and the communication gear are the limiting factors.

More vendor savings are expected to come from a sharp drop in the need for technical support. Since the software will not be on customers' computers, the software will be optimally formatted. Such is not the case when an application is installed on customers' computers, each of which is set up slightly differently. It's almost impossible to design an application that will run perfectly when it has to accommodate such diversity; it's those slight differences in users' computers that trigger most tech support calls. And if a problem does occur with the online service, the tech support staff can find it and solve it faster since it's right there on the vendor's equipment.

The tax preparers will have these advantages:

* No need for them to install and then debug the installation at the start of each tax season.

* If a bug does appear in the software, the CPA can be confident that the vendor can solve it quickly, rather than have to notify each customer separately and send a patch that has to be individually installed--another potential source of problems.

How will this online service affect the price of tax software?

While it's clear that vendor operating costs will go down, it's not clear whether the savings will be passed on to customers. As of mid-summer, RIA said it was still working out a price strategy for the new service, but it added that its smaller customers should see "substantial" cost savings.

THE BANDWIDTH PROBLEM

The challenge that online service faces is the so-called bandwidth problem: Stuffing huge chunks of data through conventional phone lines without suffering interminable delays, which is why the World Wide Web is often called the world wide wait. But several new high-capacity transmission options are becoming not only popular but also economical, and in the next year or two one or several of them likely will become standard for online connections.

RIA has devised a simple way to sidestep the problem and speed the transmission between its remote computers and tax preparers even if the customer has a slowpoke 28-kilobyte-per-second modem. Most data that will flow between the accountant and the remote server are low volume: just a series of numbers that can be transmitted nearly in real time. And since the tax return is calculated by the software in the high-speed remote computer, the back-and-forth transmission of that data also can be transmitted at nearly real-time speed.

The bandwidth problem surfaces when graphics--the complex images of the tax forms--must be transmitted from the remote server to the accountant. To get around this obstacle, the graphics are transmitted from the server just once and then stored temporarily (the technical term is cached, pronounced "cashed") in the CPA's computer. Then, when the calculations for the return are finished, the CPA's computer calls up the cached graphic and the tax data is dropped into it, producing the final return ready for instant printing.

THE MELTDOWN 

The move to do tax preparation online is sure to accelerate the acquisition frenzy--where larger vendors are acquiring smaller vendors. Less than a decade ago, more than a score of major tax software vendors populated the tax-prep software market. And if you count the small vendors with limited-range software (those with a limited number of tax schedules or forms and only a handful of states), that number about doubles.

In those days, with few exceptions, the software was designed to work on the disk operating system (DOS). Then came Windows--revolutionizing the marketplace. Most tax preparers were not eager to upgrade to Windows: After all, the early versions of the graphical operating system were slow and--worse--unreliable. Also, a Windows upgrade required a major hardware upgrade, and, unlike now, hardware was relatively expensive. In addition, many customers just didn't want to switch: They were comfortable with the look and feel of the all-text screens.

But most vendors eventually saw the handwriting on the wall--and it was writ in Windows. They recognized that, like it or not, users would soon migrate to Windows, and they had to be prepared for that move--even though the cost of rewriting software code would run into the millions of dollars. Some vendors either lacked that much capital or doubted they could recoup their investment in such a crowded market. A few sought shortcuts to Windows: Instead of a full rewrite, they added interface software--called Windows scraping--that gave their products a Windows-like appearance. Although it worked, Windows scraping slowed the tax software and created other technical problems. Other vendors just bided their time, milking the last drops of revenue from their aging products and waiting for a competitor--many of whom were waiting at their doorsteps--to offer to buy their customer list.

By the mid-1990s, some of the financially strong vendors began to introduce Windows products, but because some customers were reluctant to switch, a few vendors felt a need to offer both DOS and Windows versions--an expensive option.

It was about then--just past the mid-1990s--that the wave of acquisitions accelerated, and it continues today. Only a handful of DOS tax software products remain. It's hard to imagine that any will be around after 2000. It's even more difficult to imagine what the tax software industry will look like in the years ahead--although the trend appears to be moving to an online environment. And that trend will affect all software--from accounting to word processing and even to games. It looks as if the day of owning software is coming to an end. We soon will be paying for software as we use it--much like the way we pay for electricity. In addition, we will be assured of having the latest products all the time--without a need to upgrade every year or two.

A snapshot of major tax software acquisition history

1997: RIA buys Creative Solutions.

1998: RIA buys CLR.

1998: CCH buys Pencil Pushers--then Terminated support.

1998: Intuit buys Lacerte.

1999: Intuit TaxByte, to Terminate support by October.

RELATED ARTICLE: EXECUTIVE SUMMARY

* THE TAX SOFTWARE INDUSTRY, already buffeted by wrenching consolidations fueled by the swing to Windows, now faces a new technological challenge: the Internet. And as with Windows, either tax software vendors meet the challenge or face possible extinction.

* STARTING THIS TAX YEAR, at least one vendor, RIA, is offering the option of putting its complete GoSystem Tax software on its servers, and tax preparers will do their clients' returns remotely via direct high-speed communication links or the Internet. Both the tax software and the clients' data will reside on RIA's remote computers.

* SETTING UP BANKS for high-speed computer servers and communication hardware is not cheap, and since smaller vendors will be hard put to finance such a venture, it's probable that the wave of consolidation that has plagued the industry for nearly a decade will accelerate.

* FROM THE VENDORS' POINT of view, the advantage is clearly financial. Aside from the cost of the hardware (computer servers and communication gear)--which admittedly is an expensive initial investment--it doesn't cost any more to provide the service to one customer or to 1,000 or even a million.

* THE TAX PREPARERS WILL HAVE TWO major advantages: No need to install and then debug the installation at the start of each tax season. And if a bug does appear in the software, the CPA can be confident that the vendor can solve it immediately.

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.