TEI comments on mandatory efiling initiative: March 4, 2005.
On January 11, 2005, the Internal Revenue Service issued proposed and temporary regulations requiring that certain large corporations file their corporate income tax returns electronically beginning with the 2005 return year. The regulations were published in the January 12, 2005, issue of the Federal Register (70 Fed. Reg. 2012, 2075). A hearing is scheduled for March 16, 2005. TEI will testify at the hearing.
Tax Executives Institute is the preeminent association of business tax executives in North America. Our more than 5,400 members represent 2,800 of the leading corporations in the United States, Canada, and Europe. TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner.
Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members--and their colleagues from their companies' IT departments--enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations requiring the electronic filing of corporate tax returns under section 6011(e) of the Internal Revenue Code.
The recent temporary and proposed regulations mandate the electronic filing of large corporate tax returns for taxable years ending on or after December 31, 2005. TEI supports the goal of increasing the IRS's use of technology (e.g., including its ability to effectively process efiled returns). An effectively designed and implemented efiling process will give the IRS the information it needs in a more timely manner and without the transcription errors that may occur when data from paper returns are entered into the IRS's computer system.
Regrettably, mandating a laudable goal does not ensure its fair implementation. In TEI's view, the regulations can be seen as improperly shifting the responsibility for compliance to the taxpayer without regard to the cost and shortcomings of still-to-be-developed third-party software. If the software vendors cannot provide compliant software or if the IRS's systems cannot accept the returns, the taxpayer may face rejection of elections that must be made on a timely filed return or excessive penalties for failure to file. Unlike the development of the Schedule M-3 (relating to book-tax differences)--where the IRS actively sought taxpayer input and worked to address concerns before the schedule was issued--this mandate was issued without consultation with the constituency that will be most affected, the large corporate taxpayer community.
TEI has specific concerns about three aspects of the proposed and temporary regulations:
First, we are uncertain whether the IRS has made the case for mandatory efiling and, more important, for issuing the guidance as immediately effective temporary regulations (albeit for returns filed in 2006). Had the IRS issued proposed regulations, the process of soliciting comments not only from vendors (who will make money from the mandate) but also from taxpayers (who will have to spend it and bear the consequences of the mandate) could have been less hectic, more orderly, and in the final analysis, more realistic and fair.
Second, although the preamble to the regulations asserts that the efiling mandate will benefit taxpayers, we question whether the IRS has adequately documented and demonstrated what those benefits are. These benefits should be clearly spelled out for taxpayers. Mandatory efiling cannot help but exacerbate the burdens to corporate information reporting systems posed by the American Jobs Creation Act of 2004, the continuing demands of the Sarbanes-Oxley Act, the Schedule M-3 (itself a new mandate), and other resource-draining mandates. We appreciate that the IRS may benefit from efiling, and agree that for some corporate taxpayers the mandate may represent little more than redirecting information from the printer to the Internet. For larger, more sophisticated taxpayers--especially those with significant foreign operations or those contending with multiple, nonintegrated legacy IT systems--that will almost certainly not be the case. Thus, for these taxpayers, mandatory efiling (especially without a reasonable transition period) represents little more than outsourcing a compliance responsibility from the agency to the taxpayers.
Third, while the devil is in the details in terms of what will actually be required and how difficult it will be to transition from current practice to the efiling of corporate returns (and to the IRS's examination of those returns), we regret that the regulations presume 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 help prepare their returns, but preparing the return of a Fortune 500 taxpayer (which could easily exceed 10,000 pages in length) 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 "homebrew" solutions. In these circumstances, converting the pieces into one XML file for efiling presents very real technical challenges. We are concerned that the technological challenges of efiling--especially for the first year--may shift the focus from the quality of the return to the mechanics of compliance. Moreover, viewing the completed file may also be an issue for taxpayers because, thus far, the IRS has not published its "style sheets" for viewing electronic forms. A timetable for the "deliverables" to the IRS needs to be established and published.
Like many of us in the private sector, the IRS knows full well the challenges of meeting system modernization objectives. Rather than simplifying the preparation of corporate tax returns, the regulations may even hinder tax administration, for example, if the standard attachments that have hereto been filed with the return cannot be transmitted (or received) electronically.
For these reasons, TEI strongly recommends that a decision concerning the effective date of the regulations be deferred at least one year until the IRS has adequately tested the filing of large corporate returns (some of which approximate three gigabytes). In order to make this mandate work, the style sheets must be released within the next few weeks.
I. An Alternative
TEI suggests that rather than requiring the electronic filing of an entire corporate tax return the first year, the IRS permit taxpayers to file selected forms (e.g., the first four pages of the Form 1120 and the Schedule M-3) for which most vendors have already established data standards. This will permit the IRS (and taxpayers) to test the initiative on a smaller scale for the 2005 tax year. It will also give the software vendors more time to focus on individual forms.
II. Effective Date of Regulations
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 almost immediately (February 12, 2005).
Temporary regulations are generally issued when there is some urgency requiring immediate guidance. Prior to the issuance of these regulations, section 6011(e) of the Code was generally cited in respect of the filing of information returns such as the W-2 or Form 1099. Prior guidance indicated that the number of forms filed by taxpayers was not to be aggregated to reach the 250-form filing threshold. Thus, Notice 90-15--issued shortly after the enactment of section 6011(e)--referred only to information returns and applied the 250-form threshold separately for each type of form. Thus, a taxpayer who was required to file 350 returns on Form 1099-INT and 200 returns on Form 1099-MISC for a calendar year was not required to file the latter forms on magnetic media. The proposed and temporary regulations, however, now require the aggregation of all types of returns in determining the 250-return filing threshold. Thus, most, if not all, TEI members work for companies that exceed the 250-return threshold.
Many large taxpayers have been filing Forms 940 and 941 electronically for several years. The development of this process, however, did not occur overnight. Efiling of employment tax returns was a joint project between the IRS and the affected taxpayers (generally, payroll providers) that took well more than a year to develop. And this was an area where taxpayers were changing from one form of magnetic media to another--not starting from scratch with the development of an XML platform to file their returns. It is unfortunate that this collaboration did not take place in respect of the development of these regulations. Taxpayers will also spend considerable time and resources this year in order to bring their systems into compliance to file the Schedule M-3. To impose the mandatory efiling of income tax returns on top of this retooling may well overload taxpayers, their IT departments, and software developers.
Given the deviation from prior guidance and the significant administrative difficulties we perceive with this initiative, we believe that the use of temporary regulations is unwarranted. TEI strongly recommends that the effective date of this initiative be deferred for at least one year. In order to make this mandate work, the style sheets must be released within the next few weeks.
III. Hardship Waivers
a. Statutory Authority. Section 6011(e)(2)(B) requires the Secretary, prior to issuing regulations requiring entities to file returns on magnetic media, to take into account the ability of the taxpayer to comply with the requirements of the regulations "at reasonable cost." Although Prop. Reg. [section] 301.6011-5(b) provides that taxpayers may be granted waivers for "undue hardship," the preamble suggests that cost is apparently not considered a hardship. Specifically, the preamble states:
After carefully evaluating the benefits of electronic filing and the burdens that might be imposed on fliers, the IRS has determined that taxpayers will be able to convert to electronic filing at a reasonable cost and that the benefits to both the IRS and taxpayers significantly outweigh the costs.
TEI respectfully suggests that the IRS cannot ignore the statutory language by blithely declaring that the cost of compliance is reasonable. (Saying it does not make it so.) Moreover, the statement abrogates Treas. Reg. [section] 301.6011-2(c)(2)(i), which provides that the principal factor in determining hardship is the amount by which the cost of filing with magnetic media exceeds the cost of filing in another manner. Thus, consistent with the statute and regulations, cost should remain a principal factor in obtaining a hardship waiver.
b. Waivers for Other Reasons. Taxpayers will need significant time in which to obtain and install the software needed to efile their returns. In addition, taxpayers will need significant time in which to test the new program to ensure that the return to be efiled is accurate and complete. TEI is concerned about the ability of taxpayers to meet the deadline imposed by the regulations. We recommend that the purchase and use of software developed by an approved vendor be sufficient evidence that a taxpayer has made a good faith effort to comply with the regulations. Technological failures beyond the control of the taxpayer should also not result in the assertion of penalties.
For this reason, TEI recommends that waivers be granted--especially during the first year or two--in the following circumstances:
* Where the software vendor used by the taxpayer is unable to produce the software needed to efile any return or schedule within a reasonable time period, perhaps six months before the end of the year for which the return is to be filed (i.e., by June 30, 2005, for calendar-year taxpayers).
* Where the taxpayer discovers significant flaws in either the developer's software program or its own self-developed software during the first three months of the year in which the return is to be filed (i.e., by March 31, 2006, for calendar-year taxpayers).
* Where the taxpayer after significant testing determines the need to switch software vendors in order to comply with the efiling mandate.
* Where the taxpayer's attempts to timely file the return electronically by the statutory deadline (including extensions), but transmission errors (such as Internet traffic, misrouting of information packets, or disconnects in the transmission) prevent the filling of the return.
IV. Effect on IRS Audits
The use of standardized, efiled forms may produce the unintended consequence of impairing the IRS's goal of becoming more current on audits. Many attachments previously provided by taxpayers--such as information on a per-company basis within the consolidated group--may not now be included with the returns. In addition, taxpayers may now provide the IRS audit team with a CD (or other electronic) version of the filed return within a short period of time after the most current return is filed through conventional means. It is uncertain whether many companies will be able to provide such a service, since the efiled return may well be available only in one electronic format. If the IRS ends up with less information than with the current system, taxpayers will undoubtedly be required to provide more data on audit--a result that will slow down the process and impede the IRS's pre-audit planning.
Some members report that their audit teams have already stated that they will continue to request a paper copy of the return with the opening information document request. Such a process may well defeat any efficiencies that the government hopes to gain through the electronic filing of returns and will minimize the benefit to taxpayers. TEI recommends that the audit procedures be revised to ensure that taxpayers will not be required to produce a paper copy of an electronically filed return.
V. Technological Challenges Relating to Efiling
Perhaps the most important issue with the proposed regulations is how taxpayers are to comply with the law. If the IRS believes that taxpayers need only flip a switch to file electronically, it is mistaken.
The regulations mandate electronic filing of corporate returns, but fail to identify how that is to be done. Members of the Institute have met with the IRS to discuss many of these technical issues and other meetings (some of which will include several software vendors) will likely ensue. TEI is committed to working with the IRS to resolve these issues.
a. Availability of IRS "Style Sheets." For any form or statement where an IRS "schema" exists, the taxpayer must prepare an XML file. Inserting information prepared by a third party will be difficult since it will most likely have to be re-keyed to the XML platform. More important, with every schema, a taxpayer needs access to a "style sheet" to view the information in an XML file. We understand that the IRS has prepared such sheets, but they are not currently available to the public. This is equivalent to not publishing standardized forms or schedules. If the style sheets are not made public, it will be extremely difficult for a taxpayer to review the accuracy of the return. In addition, a taxpayer will still need to prepare a traditional copy of the return. More important, without the style sheets, taxpayers will not be able to "read" the return in the same format as the IRS audit team.
TEI understands that there may be proprietary issues relating to the release of the IRS style sheets, but taxpayers should not be forced to endure the consequences of IRS inaction. We commend the IRS for working to resolve these issues, but must reiterate that for the efiling initiative to succeed, these style sheets must be made available to the software vendors and taxpayers as soon as possible. Indeed, given the importance of the style sheets in reading the return, we strongly recommend that the initiative be delayed if the sheets are not available within the next few weeks.
b. Use of Multiple Software Programs. The regulations seemingly assume that taxpayers use only one form of software to prepare their returns. In reality, taxpayers may use several types of software--including Excel spreadsheets--to prepare their returns. These programs are not always compatible with one another and significant manual operations are often required. In addition, companies may use a third-party service such as the CCH forms software to prepare selective schedules; these forms will not be integrated with the primary tax compliance software. In addition, moving data from one software product to another will likely be costly. Finally, it is disconcerting that two out of the three top providers of software are thus far not approved vendors.
c. IRS System Testing. Although the IRS will soon undertake an engineering study, we are concerned that the efiling process has not been stress-tested under real filing conditions. This is the first XML-based system the IRS has used to receive tax returns over the Internet. Given that in February 2004, the system was capable of accepting only 59 different forms (with others added later in the year), we are concerned whether the process for receiving corporate returns that may contain thousands of pages has been adequately tested. Although 330 taxpayers efiled their corporate returns last year, we understand that not one software provider has electronically filed an actual corporate return of any significant size or complexity. Thus, the system must be truly tested under real filing conditions.
In addition, there is concern about a significant number of large taxpayers trying to efile their returns on the same due date (including extensions) of the returns--September 15 for calendar-year taxpayers. If the taxpayer uses a web-based product to electronically file, additional bottlenecks may occur when several large users try to access the product at the same time. Other issues that need to be resolved include the ability of the IRS system to (i) accept returns and attachments that may have several gigabytes of data; (ii) accept consolidated returns with multiple foreign and domestic entities; and (iii) provide a secure and encrypted format to file returns over the Internet. In other words, the test must reflect real taxpayer data drawn from multiple sources and formats.
d. Acknowledgments. The IRS's FAQ accompanying the issuance of the proposed regulations states that for nonstandard data, IRS's system will accept attachments. It is unclear whether taxpayers are to submit a single, large PDF file that incorporates nonstandard data (i.e., data not on a prescribed form), or if separate PDF files are required for different tax forms and purposes.
Moreover, individuals electronically filing their returns often wait 24-48 hours to receive confirmation that the return is accepted. Although the use of the XML platform may reduce this period, the new regulations may effectively shorten the amount of time that taxpayers have to file their returns (since to avoid penalties, taxpayers may have to file several days in advance to ensure that the return is timely received). These issues need to be addressed and guidance provided to taxpayers as soon as possible.
e. Error Messages. In 2004, the State of Michigan required corporations to electronically file their state tax returns. TEI members report that there were platform incompatibilities between taxpayers' desktop software and the vendors' ability to transmit. In some cases, it took almost six weeks before the issue was resolved by trial and error. In addition, the error messages from the State did not describe the problems. This experience highlights the importance of clearly identifying the cause of errors and giving taxpayers sufficient time to respond. But perhaps even more important, the problems encountered with the Michigan initiative highlight the need to provide adequate notice to taxpayers and software providers.
The IRS's FAQ refers to standardized error messages. It is important that these messages clearly identify which data or forms are producing the error message. Taxpayers must also be given sufficient time in which to resolve the errors. Finally, the IRS should announce that penalties for failure to file will not be imposed when the taxpayer has made a good faith effort to respond to and correct error messages.
f. Issuance of Revised or New Forms. The IRS occasionally changes the forms and may wait until the last minute to publish the new ones. For those taxpayers wishing to file shortly after the end of the year, releasing a form in December or January poses problems. If it is now an electronic form, there is minimal time to modify the taxpayer's data systems to capture it in an XML format. Moreover, making changes in a company's computer systems may run afoul of the Sarbanes-Oxley Act's internal control requirements (which requires adequate time to test the systems). With efiling, it is critical that these revisions be issued as early as possible, preferably well before the end of the year.
VI. Guidance Package
The IRS should create a guidance package aimed specifically at large corporations to address the above issues. The FAQs provided thus far are a start, but they provide less guidance than is available to efile providers and electronic return originators. The guidance package should address (1) "simple" large corporate efilers (i.e., those that rely on a single approved software vendor for all compliance); (2) "complex" corporate efilers (i.e., those that employ multiple third-party software packages, develop their own compliance software, or employ a mixture of both), and (3) "electronic return originators" and those taxpayers that rely on third parties to transmit the return. The package should also be in language that a non-IT person can understand.
Tax Executives Institute appreciates this opportunity to present its views on the proposed regulations relating to the electronic filing of certain corporate tax returns under section 6011(e) of the Code. If you have any questions, please do not hesitate to contact Paul O'Connor, chair of TEI's IRS Administrative Affairs Committee, at 978.715.1232, email@example.com, or Mary L. Fahey of the Institute's professional staff at 202.638.560, firstname.lastname@example.org.
(1) We note that the Government Accountability Office's January 2005 report on high-risk areas identified the IRS's business systems modernization program as a high-risk area, noting that problems persist "that have plagued past systems modernization efforts and that continue to affect the IRS's ability to successfully modernize its operational and financial systems." Although the GAO report focused primarily on the IRS's financial management system, it highlights the dependency of the resolution of these problems on modernization of the agency's entire business system. In January 2005, the Treasury Inspector General for Tax Administration also expressed concern about security weaknesses in the IRS's technology systems.
(2) Form 8508, Request for Waiver for Filing Information Returns Magnetically, requires the taxpayer to submit two current cost estimates from third parties for software, software upgrades, or programming for the taxpayer's current system, or costs for preparing the electronic/magnetic media files for the taxpayer.
(3) In many cases, company firewalls may currently prevent the tax departments from filing returns over the Internet.
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|Date:||Mar 1, 2005|
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