The Commission believes that the IRS must develop and implement a strategic and marketing plan to make paperless filing the preferred and most convenient means of filing for the vast majority of taxpayers. This vision can be achieved over a ten-year period by using existing infrastructure such as tax practitioners, financial institutions, and the Internet as intermediaries for submitting tax returns to the IRS. The obstacles to achieving this vision are not necessarily the cost of developing information technology systems, but entering into a partnership with practitioners and financial institutions that would provide burden reductions and incentives for filing tax returns electronically.
Table G-1 illustrates IRS tax return processing workload for 1995. IRS estimates that 120 million individual tax returns will be filed in Tax Year 1996, of which approximately half, or 60 million, will be prepared by paid tax preparers. Virtually all of these 60 million returns are prepared using tax preparation software. Another 10 million or more tax returns are filed by self preparers who use consumer-oriented tax preparation software products.
Table G-1. Return Types Received by IRS for Tax Year 1995
IRS estimates the average cost of processing all paper returns at $2.65 a return, but acknowledges that this figure did not include all costs. Similarly, the costs of processing electronic returns was estimated at $1.15, including the processing of paper signature documents. The IRS is conducting a cost study to determine the actual costs. The Commission received an estimate from the Private Sector Council that a project by a Fortune 100 company to automate paper processing experienced a six to one cost differential of paper to electronic processing costs. This represents a significant cost savings for the IRS if the number of electronic returns can be increased significantly.
In addition to labor, overhead, and management costs to operate the returns processing pipeline, there are other cost reductions that could be realized with an increase in electronic filing, such as the following:
· Heavy dependence on manual labor creates additional
recruitment and training costs for IRS since it causes spike demands
for low cost labor that is not always available.
· Facility and physical handling equipment associated with paper filing is much higher than that used for electronic returns.
· After the data is manually entered into the data base, the paper return is archived. Storage costs for paper returns are higher than those for electronic returns. Any subsequent need to access a return, such as an examination or collection, or requests by taxpayers for a copy of the return, results in retrieval costs as well.
To save processing costs, the IRS currently only captures in electronic form 40% of the information submitted on paper returns. All paper data submitted by taxpayers is archived, however. After a return is posted to the Master File, IRS uses automated algorithms to detect conditions that may warrant an examination. For those returns selected for further evaluation, the paper return must be retrieved from archives, and examined manually. With electronic returns, 100% of data submitted are captured and archived electronically. This situation provides the opportunity for the IRS to enhance its detection algorithms to use an expanded set of data, while also reducing the need for retrieval of suspicious paper returns. Since this type of examination occurs without any taxpayer contact, it is the least intrusive type of examination.
Reasons for failure of existing electronic filing program
The Commission believes that the failure of electronic returns to increase at rates originally projected by the IRS does not represent a technical failure by the IRS, rather a failure to plan and market electronic filing in an organized, thoughtful manner. As early as July 1995, GAO reported that IRS had no comprehensive business strategy for promoting the benefits of electronic filing to all taxpayers. Rather, its strategy was aimed only at taxpayers desiring a quick refund. Without a comprehensive strategic plan, GAO believed that IRS would not achieve its stated goal of 80 million electronic returns by 2001. The Commission believes this situation is still true today. No comprehensive strategy has been made available to the Commission, although a high level issue paper was released by IRS in February, 1997.
Mr. Peter Simpson, Second Commissioner for the Australian Taxation Office (ATO), testified to the Commission that the technology costs for electronic filing were low, but the real keys to success were marketing the service properly and letting the private sector develop products in the marketplace. The Commission received testimony and input from the practitioner community that would confirm ATOís experience.
Information returns and document matching
Electronic filing of both tax and information returns aids earlier document matching. With todayís filing profile and legacy systems, IRS delays the identification of underreporter cases for over a year until all the documents are ready to be matched. Receipt by taxpayers of underreporter notices 18 months after filing increases the likelihood of missing taxpayer records and builds taxpayer resentment against the IRS due to the accumulation of interest and penalties.
Although it is not currently possible to perform document matching before a refund is issued, electronic filing of information returns could allow IRS to perform document matching in the same calendar year during which a tax return was submitted. Underreporter cases could then be pursued in a more timely manner. The IRS should perform income reporting verifications through matching of 100% of submitted information documents. IRS also should include the Schedules K-1 as part of the document matching process.
The Commissionís comprehensive plan for increasing electronic filing is summarized in Table G-2. The Commission believes only a comprehensive plan that appeals to all segments of the taxpayer and practitioner population can make electronic filing the preferred and most convenient method of filing for the vast majority of Americans. Features of the plan are described in the following paragraphs. While this plan focuses on individual tax returns because they constitute the bulk of the IRS processing workload, the Commission emphasizes that plans should be established to encourage all returns types, such as payroll, corporate, and partnership returns, to be filed electronically.
Partnering with stakeholders
IRS needs an improved sense of partnership with tax practitioners, other organizations that supply data, and state tax administrators. We recommend IRS establish an Electronic Commerce Advisory Group (ECAG) to address issues of mutual concern to IRS, the practitioner community, other stakeholders, and state tax administrators. The Commissionís intent in recommending establishment of this group is to establish an ongoing forum for discussing future electronic commerce issues.
The Commission envisions that the ECAG would address issues to help further electronic commerce among the member organizations, such as the removal of additional barriers faced by practitioners, simplification of the application to be an Electronic Return Originator (ERO), and plans to achieve complete participation by all states in the Federal/state electronic filing program. Additionally, as the IRS moves to more paperless tax administration, the ECAG is envisioned to be a forum where IRS and practitioners can mutually facilitate the ability of tax practitioners to move to more paperless business systems, such as paperless records retention systems.
Additional changes to improving partnering between IRS and preparers involve treating practitioners as valued suppliers of information to IRS. The Commission recommends such changes as elimination of filing requirements for signature documents and associated W-2s by having taxpayers retain signed 1040s and W-2s on file, regulation of all paper and electronic preparers under IRS Circular 230 to ensure standard procedures for treatment of all tax preparers, inclusion of a checkoff box on the electronic tax return that allows taxpayers to authorize their preparer to discuss aspects of the return with IRS Customer Service Representatives, accepting of the transmitterís date/time stamp as a postmark, and development of a white field in the electronic return for tax preparers to include supplementary notes.
Elimination of Form 8453
The filing of Form 8453, the signature form for electronic returns, has been identified by practitioners as a major impediment to the efficient filing of electronic tax returns. IRS also reported to the Commission that the handling of these forms is the largest cost element associated with the processing of electronic returns. The Commission believes the filing of this form is unnecessary. Several models exist where organizations accept electronic tax returns without signature documents, including Canada, Australia, and the state of California. In addition, the Securities and Exchange Commission accepts electronic financial reports such as 10-Ks without signatures. In each of the above cases, the only requirement is for the originator to maintain the signed copy on file. While the Commission believes that electronic authentication technology will make electronic signatures viable on a national basis, the infrastructure does not yet exist to support such a program. The elimination of the Form 8453 should not wait until this technology is in place. A change to allow taxpayers to maintain the original signed copy of their returns will require legislative action, since current Treasury interpretation of existing law is that a signature is required.
Acceptance of all forms
Another significant barrier brought to the attention of the Commission by practitioner groups is that IRS does not accept electronically every form or schedule that can be attached to the 1040. As an incentive for IRS to modify its systems to accept all attached schedules, the Commission recommends that IRS, starting in 1998, accept all 1040s electronically. If certain attached schedules cannot be received electronically by IRS, the taxpayer should simply be required to maintain these forms in their records, much like a worksheet is treated today.
Regulation of preparers
Regulation of all preparers under Circular 230 is important to the development of an improved relationship between preparers and IRS, since it applies enforceable rules of conduct to all return preparers. Our recommendation is to amend 31 U.S.C. 330 to require all persons engaged in the business of preparing returns or otherwise accepting compensation for advising in the preparation of returns to comply with the standards of conduct set forth in Circular 230 as enforced by the Office of the Director of Practice which is established under Treasury. By holding all paid preparers to the same levels of due diligence, the proposal seeks to ensure that taxpayers are not misled by their representatives. Return preparers that violate the rules of conduct are subject to disbarment from return preparation or representation of taxpayers before the IRS. The ability of the Director of Practice to administer and enforce actions based on allegations of professional misconduct should not be compromised by the organizational placement of the Director.
Uniform requirements will increase professionalism, encourage continuing education, improve ethics, and better enable the IRS to prevent unscrupulous tax preparers from operating. Regulation under Circular 230 promotes the integrity of our tax system, places all return preparers on a level playing field, promotes voluntary compliance and standardizes the procedures for all preparers for electronic filing and other compliance procedures. Currently, commercial return preparers are allowed to represent taxpayers before the IRS at the examination level and only for returns which they prepared. Higher education and qualification criteria should continue to be enforced for representation at all levels before the IRS. The Commission does not envision complex and cumbersome registration procedures or requirements, simply a system to capture preparer information already provided on the tax forms for a database of preparers.
Realignment of due dates
The complete schedule for revised due dates is shown in Table G-3 and G-4. The Commission believes these changes better support same year document matching and possible future implementation of simpler return filing processes, such as return free filing.
Expansion of TeleFile pool
TeleFile is considered by IRS and the Commission to be a successful program. The number of taxpayers using TeleFile increased approximately 50% in 1996 to close to 5 million filers. To encourage even more taxpayers to use this method of filing taxes, we recommend that IRS consider expanding the TeleFile pool in two ways. The first method is to expand the TeleFile pool by including more taxpayers now filing 1040A returns. This expansion currently is being evaluated by IRS and if IRS assessments indicate favorable benefits, the expansion should be accomplished. A second approach is to expand the number of 1040EZ filers by changing the limiting conditions so that additional taxpayers could use the simpler form and thus be eligible for TeleFile.
The Commission also recommends that paperless payment methods be made available to taxpayers. This option could be as simple as using the existing direct deposit blocks in reverse to authorize an electronic transfer of funds to the IRS. Other options include the use of debit and credit cards. Some municipalities and states have already started allowing the use of credit cards for payment of taxes. Typically, the taxpayer must absorb the cost of any merchant fee when using credit cards to make tax payments. Receipt of tax payments also could be privatized through electronic funds transfer or submission of paper payment to a financial institution or other third party processor for electronic transfer to IRS.
A major incentive for tax practitioners is a combined incentive and required electronic filing plan to encourage practitioners to file electronically, and requiring practitioners not to charge taxpayers extra for electronic filing if they accept the incentive payments. The Commission recommends that IRS pay transmitters an incentive for submitting electronic returns until 2004. Transmitters would be expected to share the payment with originators based on market competition. The recommended payment schedule is shown on Table G-2. A second incentive, one geared to taxpayers, is faster refund cycles.
The Commission believes that this plan offers several benefits. The incentives provide a short term benefit to transmitters and originators and provide taxpayers with free electronic filing services. Surveys indicate that the cost of electronic filing is a major reason taxpayers do not file electronically. Incentives, combined with other changes to make electronic filing more attractive, are expected to increase volume and encourage market dynamics to react with competitive products in sufficient numbers to provide taxpayers with a range of choices. Based on briefings the Commission received from industry, there are already signs that this marketplace development is beginning. The Commission recommends that regulations concerning electronic filing should be examined to ensure they do not impede the development of products in the marketplace that facilitate electronic filing.
Table G-3. Information Return Preparation and Processing Dates
Table G-4. Tax Return Preparations and Processing Dates
In 2004 incentives will terminate and all practitioners will be required to file electronically. The Commission believes this requirement also encourages the market to develop products, while at the same time providing more than adequate time for practitioners to prepare for the requirement. Many practitioner groups have told the Commission that they support this requirement as a means to get the industry to adopt electronic filing as common practice.
As more Americans have personal computers (PCs) in their homes, filing tax returns from home should have more appeal to taxpayers. The Commission envisions that the marketplace will develop systems that will allow taxpayers to file directly from their home PCs, and using appropriate security and privacy safeguards, independent of any IRS action. Should this situation not occur, we recommend that IRS develop systems to allow taxpayers to transmit tax returns directly to IRS using home computers. One example of a market development that could occur is for banks and other financial institutions to incorporate options for electronic filing as part of home PC banking services, offering competitive tax filing services as part of an overall package of products available to customers. Other organizations could offer the same or similar services.
Secure access to taxpayer records
The Commission recommends that IRS allow taxpayers and their authorized practitioners who file electronic returns be provided secure access to their own account information by 2006. We recognize that this capability cannot be achieved until IRS first integrates its data bases, but we believe this capability should be planned for and developed as part of modernization, and not added as an additional requirement in the next century. Banks currently offer this feature to customers who participate in home banking services. As the number of consumers participating in home banking grows, this feature becomes another capability taxpayers will expect for their IRS account as well.
Changes to IRS systems and procedures
IRS changes to complement the above actions would include less restrictions on advertising to improve taxpayer understanding of the benefits of electronic filing, acceptance of all form types and addition of a white field for supplementary notes, more frequent payment cycles for electronic returns, and expansion of IRS infrastructure to accept more than 100M returns.
Filing of Form W-2
The Commission recommends that the current threshold for magnetic/electronic reporting to the Social Security Administration (SSA) be lowered. The current procedures require submitters of more than 250 W-2s to file using magnetic or electronic format. The Commission recommends this threshold be lowered to 100 W-2s, and that the threshold be applied in the aggregate to third party preparers. The immediate goal is to reduce the 53 million paper W-2s, with the long range goal of using incentives to transition to electronic filing.
We also recommend a single point of filing of Forms W-2 and W-3 by having SSA capture all form information, including state and local information. Electronic submission of the majority of Forms W-2 and W-3 will reduce SSAís data capture burden. SSA should then transmit the captured data to the appropriate governmental agency. IRS must revise Form W-2 to add state and local information.