The President signs NAFTA - requiring most U.S. employers to deposit federal taxes electronically by 1999.

Introduction

Tax professionals should be aware how the funding provisions of the North American Free Trade Agreement Implementation Act (NAFTA) will affect them. Section 523 of NAFTA amends section 6302(h)of the Internal Revenue Code to require the Internal Revenue Service to establish an Electronic Federal Tax Payment System (EFTPS) for the collection of federal depository taxes including employment, excise, and corporate income taxes. The Office of Management and Budget (OMB) estimates that the system will raise $2.2 billion in revenue over the next five years. The revenue arises from a one-day acceleration of funds available to the government.

NAFTA sets forth mandatory targets for the percentage of federal depository taxes to be collected electronically. The requirement is phased in according to the following schedule by government fiscal year:

Government Fiscal Year   Percentage of Deposits
      1994                     3%
      1995                     16.9%
      1997                     58.3%
      1998                     58.3%
1999 and thereafter            94%

Although the NAFTA implementation strategy will be pursued initially through changes in the payroll tax deposit system, the Internal Revenue Service's ultimate goal will require deposits of corporate income and excise taxes through electronic means as well. Thus, although the balance of this article deals with the concerns arising from expected changes to the payroll tax deposit system, tax executives should consider whether other issues arise in connection with income and excise tax deposits.

TAXLINK

TAXLINK is a pilot program initiated in 1991 to study the feasibility of electronic payment of federal depository taxes. The pilot program is operating out of the IRS's Atlanta Service Center with voluntary employer participation. Employer participation to date has been low, in part because of a general lack of awareness about the test program and employer hesitation to commit resources to endeavors without cost-saving potential. In addition, existing cash management agreements with banks may preclude some larger employers from participating.

American Payroll Association (APA) and Tax Executives Institute (TEI) have raised concerns about TAXLINK at meetings with IRS and Treasury officials and representatives of the banking industry. A summary of those concerns and the status of the IRS's response follow.

IRS Meeting on TAXLINK

On November 8, 1993, IRS Commissioner Margaret M. Richardson convened a meeting among IRS officials, APA, and TEI representatives to discuss the issues raised. The IRS officials included Deputy Commissioner Michael Dolan, Chief of Taxpayer Services Judy Van Allen, Deputy Chief Information Officer Wallace Hutton, and TAXLINK Project Manager Lillie McCracken. The employer community was .represented by members of APA and TEI. Three principal issues were discussed.

1. Timing of Deposits

In order for a funds transfer to settle by opening of business on the tax due date, TAXLINK requires employers that are next-day depositors to initiate their electronic payment instructions on check date! This may pose a substantial or even impossible burden for large, decentralized next-day depositors. These employers will encounter difficulty computing payroll deposit liabilities, reconciling data, moving funds, and performing other tasks timely to initiate a tax payment on check date under the demands imposed by the Automated Clearing House (ACH) system. Furthermore, the current Fedwire system does not permit prompt payment posting to meet the government's information needs. In addition, semi-weekly depositors may lose a day of processing time for their payroll systems.

2. Acknowledgement of Receipt and Proof of Payment

The employer representatives explained that employers require an electronic (or some other) acknowledgement of receipt of payments under the ACH credit option. Under the current deposit rules, the date-stamped Form 8109 Federal Tax Deposit (FTD) coupon serves as an acknowledgement and establishes employer due diligence in meeting its deposit obligations.

3. The Need for Clear Rules for Employer "Due Diligence"

Employers need clear, concise regulations on what constitutes due diligence when making electronic payments. Under the rules governing the current TAXLINK pilot program, employers choosing the ACH credit option for payment of payroll taxes remain liable for the payment from the time payment is initiated until "credited to the Treasury's account at the Federal Reserve Bank." (See Rev. Proc. 93-26, 1993-23 I.R.B. 34 (June 14, 1993), TAXLINK Test-Procedures for Participating Federal Tax Deposit (FTD) Taxpayers and Financial Institutions.) The employer representatives argued Strenuously that employers can only control their actions, not those of the banks, and that once employers initiate a payment with proper instructions and funds are available in the account, the employer's exposure to penalty liability should end.

IRS Response to Employer Concerns

On December 16, 1993, representatives from APA and TEI met again with Commissioner Richardson and senior IRS officials. Jack McGuire, TAXLINK project manager for the Financial Management Service (FMS) of the Treasury Department also attended, as did a representative of the National Automated Clearing House Association (NACHA). The purpose of the meeting was to discuss the IRS's response to taxpayer concerns.

1. Timing of Deposits

Jack McGuire of FMS stated the Federal Reserve Bank (FRB) and Treasury are holding formal discussions on the timing issue. The FRB appears open to moving its deposit deadline to a time later in the day to accommodate the needs of next-day depositors. An IRS/Treasury/FRB workgroup has been established to determine whether this is feasible, and if so, how late in the business day the deposit deadline may be set. The employer representatives suggested the time "be as late in the day as possible," and expressly recommended that Pacific Standard Time be designated "so that all employers may be accommodated." The NACHA representative, Elliot McEntee, stated that "the banking industry's ability to serve the taxpayer will depend on the precise time FMS requires the funds [to be swept electronically] and the information to be made available to the agent of the Treasury."

Mr. McEntee observed that, by January 1995, large banks might be able to allow their large corporate clients same-day settlement for the ACH credit option. He expressed doubt, however, about the banking industry's ability to implement this procedure on a nationwide basis by the same date. Mr. McEntee also expressed concern over the feasibility of same-day settlement under the ACH debit option.

Lillie McCracken, TAXLINK project manager, reported that another IRS/Treasury/FRB workgroup was exploring ways to improve the Fedwire process. One goal is to add the Tax Exchange Payment (TXP) format to the Fedwire process to enable payment data to be identified in the addendum record. The working group is targeting a January 1995 implementation. With this system change in place, next-day depositors will be able to use Fedwire as an emergency backup on the payment's due date.

Employer representatives urged that employers and banks be brought into the workgroups as soon as permissible under law. Michael Dolan, IRS Deputy Commissioner, expressed the IRS's support for employer input.

2. Employer Due Diligence and Proof of Payment

Bob Carver, IRS Deputy Assistant Commissioner Returns Processing, confirmed the IRS's commitment to devising an electronic (or some other) acknowledgement of receipt for ACH credit transactions under the new electronic system, with a working solution being available by January 1, 1995. Mr. Carver stated that for 1994, IRS would accept the gross number shown on the transfer as acknowledgement of payment of the tax, even though these electronic receipts typically include multiple records of payments and only the total dollars involved in the transfer.

Mr. Carver added that he agreed with employer groups that an employer's obligation should end under the revised system when payment is initiated and the proper amount of funds are available. Leon Kennedy, Deputy Assistant Chief Counsel, agreed that regulations would be drafted under that premise. "If the banks make a mistake," said Mr. Carver, "our issue will be with the banks."

Mr. Kennedy advised that, under NAFTA, IRS has until July 7, 1994, to issue temporary regulations implementing the EFTPS. He declared that the Chief Counsel's Office would require guidance from IRS policy makers by March in order to issue regulations by the July deadline. In response to a question, Mr. Kennedy expressed doubt whether the NAFTA deadlines will permit IRS to issue regulations initially in proposed form.

IRS Asks for Volunteers

IRS Commissioner Richardson invited employers to volunteer for TAXLINK in order to meet the fiscal 1994 goal of collecting three percent of all federal depository taxes electronically. By volunteering to participate in TAXLINK, employers will have an opportunity to work with IRS and Treasury to design a workable system for depositing federal taxes electronically. lf you wish to participate in TAXLINK, or desire more information before deciding, you should contact the IRS at the TAXLINK helpline at [phone].