Electronic tax compliance - the wave of the future.
The views expressed in this article, however, are those of the authors and not necessarily those of TEl or the FTA. The purpose of the article is to apprise tax executives and other interested individuals of the developments and to solicit their participation in ongoing EDI initiatives, either under the auspices of TEI's TIS Committee or otherwise. Individuals wishing to become active in TEI's activity should contact Anthony P. Verdino, the TIS Committee's chair, at (203) 352-8129. Individuals wishing more information about the FTA's activity should contact Mr. Lyon at (202) 624-5890.
Economic conditions in the 1990s dictate that virtually every business enterprise review and, in some cases, significantly alter their internal processes. The common buzzwords for this analysis include "benchmarking," "flow charting," and "process re-engineering." Often recommendations that result from such studies include eliminating paper from the process and converting to electronic data interchange (EDI). Benefits to be derived from implementing EDI are vast: streamlining data flow; improving accuracy; eliminating costly input errors; reducing headcount; reducing storage and disposal costs; improving data retrieval; and even advancing environmental objectives (such as saving the rain forests).
Most internal processes can benefit from EDI, especially those involving a large volume of data traditionally sent or received on paper, and which eventually need to be converted to machine readable media. Examples of areas in which EDI has worked extremely well are Purchasing and Invoice Processing/Accounts Payable. Using EDI, it is possible to even eliminate vendor invoices and trigger vendor payment directly from a purchase order through matching electronic receivers with an electronic purchase order. Even the payment process can be done electronically.
"What does all this EDI discussion have to do with tax compliance?" you ask. A form of financial EDI--the wire transfer--has been common for processing payments to tax agencies (including the Internal Revenue Service and many state and local tax jurisdictions) for several years. In fact, many States require electronic funds transfer (using the Automated Clearing House banking system) as soon as a company's periodic tax liability reaches some minimal threshold.
The next logical step--electronic filing of tax returns-- is already starting. The IRS has been electronically receiving individual income tax returns from tax preparation firms since 1985. Also, corporate taxpayers have been sending information returns to the IRS electronically for several years. Recently various States joined the electronic filing circuit for business taxpayers. As of March 1994, three States (Texas, Florida, and Tennessee) are receiving sales tax returns using EDI, and three more States (Colorado, Oklahoma, and South Carolina) have begun prototype programs for electronic sales tax returns with one or more trading partners. Other States are currently using EDI for Motor Fuel Excise Tax returns, Oil and Gas Production reports, and Severance Tax returns. Ten more States intend to begin receiving EDI returns before the end of 1994. A status matrix of the EDI activity of all States, derived from a survey conducted by the Federation of Tax Administrators in January 1994, is set forth in Exhibit 1.
With the expansion of electronic tax returns for business taxpayers, several concerns exist within both the business community and the state tax agencies.
With respect to electronic commerce in general, business enterprises are concerned about audit procedures by state tax authorities. It is imperative that state auditors perform audits of EDI transactions electronically and not require that paper documents be printed for their review. Such a two-tier approach would frustrate, if not defeat, the very purpose of using EDI for the business process. Another taxpayer concern is the capability to segregate data for access by a state auditor on matters involving that states' audit issues.
For electronic filing of tax returns, businesses desire standardization of EDI technical formats across all tax jurisdictions for each type of tax return. If each State can dictate its own data elements and where each of those elements are placed in the data set, then administering a multi-state EDI filing program would be cumbersome, confusing, and have a high potential for errors. The promised efficiency of EDI would be seriously compromised.
Business entities also need assurance regarding the timeliness of receipt of returns and payments. Assurances need to be made that if a third party network, or the banking facility, or the recipient State has some computer malfunction or power failure after the return and payment has been transmitted, penalties for failure to file or pay will not be generated. Similarly, data security and confidentiality of tax return information must be guaranteed.
Finally, the cost of underlying equipment, third party charges, and training are major concerns for many business enterprises, especially for small businesses.
Tax Authority Concerns
Of primary concern to the tax authorities regarding auditing of electronic data is the integrity of that data. Currently, auditors rely on source documents originating from third-party vendors to verify transactions and their authenticity. State auditors will need to access and analyze a business taxpayer's electronic systems controls. At a minimum, electronic source information must be unchangeable once a transaction is initiated. Furthermore, an electronic cross-reference or audit trail must be available to trace transactions from their initiation to eventual conclusion and posting to the business general ledger.
Tax authorities are also concerned with standards for line item detail on electronic "documents." For appropriate business documents, taxpayers that use EDI must be required to maintain for each line item certain minimum fields or data elements so that audit programs can be developed and used without modification across a wide spectrum of taxpayers.
Another concern of state tax authorities is the training of auditors to audit a taxpayer's electronic commerce. This could be a huge task and expense depending on how many of a State's trading partners adopt EDI.
National Standards for Electronic Commerce
Recognizing the need for standards in electronic commerce, in 1979 the American National Standards Institute (ANSI) chartered the Accredited Standards Committee (ASC) X12 to develop and maintain standards for EDI. In 1987, the Data Interchange Standards Association (DISA) was designated to be the ASC X12 Secretariat. DISA manages the administration of ASC X12.
ASC X12 established a Government Subcommittee, referred to as X12G, the activities of which are further broken down into Task Groups. Task Group 3 has the responsibility for creating the technical structures enabling tax administration data to be communicated in a standard format. For more than five years the FTA, the IRS, participating States, the tax software preparation industry, and a variety of business associations have been working to define a standard set of data elements that can be used in a wide variety of tax filing applications--including tax returns as well as information documents (1099s, W-2s, etc.) for individual and business taxes. Tax Executives Institute is one of the associations that has been invited to participate in Task Group 3's work.
The primary business documents, or X12 transaction sets, with which Task Group 3 is concerned are the 813 and the 151 (ANSIassigned numbers). The 813 (Electronic Filing Tax Return Data) is a transaction set that will enable a taxpayer or information reporter to file tax data with a revenue agency or other government agency. The 813 transaction set was released as a national standard following the June 1992 ASC X12 meeting. The 151 (Acknowledgement to Tax Return) was approved in October 1992.
Meanwhile, the Federation of Tax Administrators (FTA) established the Business Taxes Electronic Filing Task Group (BTTG) to explore issues relating to the implementation of electronic filing of business taxes through EDI. Within ASC X12G, BTTG is formally recognized as a workgroup under Task Group 3. The objectives of Task Group 3 (BTTG) are to:
* Create a draft list of issues and suggested recommendations regarding the technical, administrative, legal, operational, and other matters to be addressed by States in pursuing the electronic filing of business returns, information documents, and payments.
* Investigate how electronic filing can work through state and business prototype filing tests.
* Produce a report on the prototype partners' findings, with recommendations.
* Submit a final report to the FTA Board of Trustees for its consideration and approval; when approved it will serve to guide the state taxing agencies in the implementation of electronic filing of business taxes.
The issues identified for resolution by the group to date include standards for timely tax filing and proof of filing, taxpayer education and training, and records retention in EDI systems, among others. The BTTG has conducted surveys of the corporate tax community and the States, developed a preliminary report on its findings, and is working with FTA member States to enhance those results with practical experience in EDI tax filing processes before finalizing its recommendations in late 1994.
Cooperative State Effort: TaxConnect
The current strategy of EDI-aware tax agencies will be to implement EDI-based business taxes filing on a pilot basis with a small group of volunteer companies that will test the utility of electronic filing and the practicality of the BTTG preliminary recommendations. A number of organizations are aggressively pursuing EDI-based tax filing pilots. These include South Carolina, North Dakota, and Nebraska, the initial TaxConnect pilot states, as well as others (See Exhibit 2).
In addition, results from an April 1992 FTA survey showed 95 percent of the States responding interested in the concept of a cooperative effort enabling the filing of business taxes.
Anticipating the growth of electronic tax filing, a nonprofit governmental corporation called TaxNet Governmental Communications Corporation (TGCC) was formed by the FTA and the Multistate Tax Commission in 1990 to service the electronic communications needs of the States, with one of its purposes the facilitation of taxpayers' filing of tax returns and tax payment.
TGCC is qualified as a governmental entity (dual-status section 501(c)(3) non-profit organization and section 115 state instrumentality) entity, offering services as an agent (on a non-exclusive basis) to States that have determined to voluntarily participate in and use its services. A Request For Proposal for Value Added Network Services was released by TGCC in December 1992. After a competitive bid process, Electronic Data Systems Corporation was selected by a state review team from a field of six major telecommunications companies. A TGCC-EDS contract was concluded at the end of 1993, and the first state pilot implementations are expected in early 1994. This will afford taxpayers an opportunity to participate on a voluntary basis and will allow tax agencies and filers a chance to learn more about the mutual business advantages of EDI.
Through TGCC, a number of States have now begun to work together in the implementation of this electronic network for business taxes filing, providing the participating agencies the potential for significant benefits: reduced cost, spreading of risk, sharply decreased ramp time, and lessened overall implementation effort. Such a cooperative activity will not only benefit the tax agencies from a tax processing perspective, but will promote the use of electronic exchange standards across all state revenue operations in the 51 jurisdictions. It will thereby assist in reducing taxpayer compliance burden.
In general, the use of EDI for tax filing will enable taxpayers to decrease their cost of tax compliance, including reduction in effort associated with the current filing of paper information. This will allow businesses to better focus their attention and resources on value-oriented, profit-making activities.
The offer of the TaxConnect network on behalf of multiple States will mean that taxpayers will be able to take advantage of one point of electronic filing and acknowledgement, and the network will use a common and standard electronic interface for tax filing and payment with only the data requirements customized to meet an individual tax authority's needs. Other benefits include reduced risk of exposure to penalty and interest owing to timely notification of errors in tax return calculations, and positive confirmation of state receipt of ACH Credit tax payments.
TaxConnect As State Agent
How will TaxConnect operate? Exhibit 3 outlines a basic concept. The taxpayer would create a tax return in standard format and include either an ACH Debit payment instruction or an ACH Credit Trace number. This would be communicated to the taxpayer's communications agent (EDI Value-Added Network, or other communications provider). Many large taxpayers today use these networks for other business transactions (purchase orders, invoices, shipping notices, etc.). Smaller taxpayers could be serviced in the future by third-party VANs using interfaces familiar to taxpayers and using already-established and emerging technologies (touch-tone telephone, point of sale devices, etc.). The taxpayer's information could then be communicated from its VAN provider to TaxConnect. Exhibit 4 describes in more detail some of the features and business advantages of this approach.
Because they share corporations' twin goals of reducing cost and improving service, State tax agencies will continue to search for improvements in their business processes. Use of new techniques by taxpayers, such as EDI, will be emulated and leveraged for the benefit of both the taxpayer and the States. Tax agencies, however, must take steps to ensure that these new ways of doing business assure the same level of confidence in and provide real benefits to the taxpaying community, while at the same time serving legitimate needs of government.
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|Author:||Lyon, Jonathan R.|
|Date:||Mar 1, 1994|
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