As the Internal Revenue Service moves towards its goal of 80 percent e-filing for individuals, it is placing more emphasis on the e-filing of corporate returns.In 2005, over 200,000 corporations voluntarily e-filed, and beginning in 2006, many corporations will be required to file electronically. Recently issued regulations require corporations with assets of $50 million or more that file over 250 returns each year to file Forms 1120 and 1120S electronically, starting with tax periods ending on or after Dec. 31, 2005.
In 2006, the mandate threshold drops to corporations with assets of $10 million or more. For purposes of the 250-form threshold, income tax, excise and employment tax forms are included.
E-filing produces quicker processing and reduces audit cycle time, and will allow the IRS to do a better job of focusing on compliance risk, according to Elvin Hedgpeth, deputy director of international for the Large & Mid-Size Business Division of the IRS. Eventually, he noted, both the 1040 family of returns and the 1065 returns will be migrating to the platform used for corporate e-filing.
The reason for the mandate is that both large taxpayers and software developers advised the IRS that they would not e-file voluntarily.
"For corporations, they wanted uniform compliance that results from a mandate, and for software developers they were concerned about the costs of passing development costs along," said Hedgpeth at a recent IRS-sponsored Tax Talk Today panel.
Hedgpeth noted that the IRS is actually behind a number of states in mandating e-filing for corporations. "Several states now require corporate e-filing, and quite a few foreign countries require corporate e-filing," he said.
When the IRS developed its e-file system, it attempted to strike a balance between its external customers and its internal needs, according to Dayna Sefcik, manager in electronic tax administration for the IRS.
"When we worked with our external customers, a lot of them wanted no validations. Of course, looking from the internal side, we wanted everything in a perfect return," she said. "We finally did strike a balance, and how we did that is we pretty much treat the corporate returns that are filed electronically the same as a paper return."
Sefcik said that the system took four years to design, with participation from the Big Four accounting firms, software companies and electronic return originators on all phases. They also met with the Tax Executive Institute, the Association on Computers and Taxation, and Financial Executives International, and have scheduled a meeting with the American Institute of CPAs. "We had large and midsized businesses and small businesses that worked with us to make sure we didn't just focus on the needs of the large taxpayers, but also the small ones."
"What we found was that the needs of a corporate return were much different than for a 1040 return," she said. "So we had to build several enhancements into our new system."
"The latest technology to send it in is very secure," she added. "It's also very high-speed, so they can get these 50,000-page returns to us very quickly."
Sefcik said that a significant change for corporations is that everything has to be included in their tax prep software.
"Right now, many of the corporations use maybe two software packages to prepare the return," she said. "They may use other formats like Word and Excel to do their supporting data or their elections. Or the other thing is that many of them do their elections maybe in another program. They are going to have to get all of that data into one transmission file to come to the IRS, and that is going to be the challenge."
Everyone faces change
Although the e-filing mandate covers corporations with $50 million-plus in revenue, this is just the beginning, emphasized Tom Olenski, CPA and principal at Big Four firm Ernst & Young. "I think it's important to remember that next year those taxpayers are going to become part of the mandate," he said. "The mandate this year is $50 million; next year it's going to be, for those taxpayers, over $10 million."
Although many taxpayers may feel that e-filing doesn't cover them because they don't file 250 returns, Olenski pointed out that W-2s and 1099s are included. "These forms generally are going to put most companies over that limit, and therefore they will fall under the mandate," he said.
People need to realize that their processes are going to change, according to Olenski. "Tax processes have been revolving around paper for who knows how many years, and those processes are going to need to change," he said.
"Those processes are going to be built around a system where the ultimate product is an electronic file. No longer will you be able to white out a number here or there. You're going to have to incorporate your data into tax software. You're just not going to have that ability to make minor changes to a return at the last minute."
Eventually, the IRS wants all forms to be submitted in XML format, but for at least a year it will allow PDFs under transitional rules.
"The PDF solution is part of the transitional rules that are out there right now, and it's made optional in order to help facilitate the taxpayers successfully filing under the mandate," said Rick Campbell, manager of tax analysis for Deloitte & Touche Tax Technologies. "Most software companies will be providing both the XML support as well as the PDF support for the long-term."
Olenski noted that having everything in XML format offers benefits to the taxpayer. "Anytime you have a data standard, it is going to allow software vendors to create applications that may utilize this data, so every taxpayer is now creating an XML file that is in the exact same format," he said. "Taxpayers ultimately are going to benefit from this XML file that is created, because it will be a data standard that software vendors can put together that will read in that data and do projections, for example, or do planning. They'll be able to utilize the data to compare one industry with another."
The transmission perfection period is part of the changes brought on by the e-filing mandate. The 1040 e-filing has a five-day period. For corporations, the period has been extended.
"If they file an 1120 return, they have 20 days to correct any reject that might occur, and that is after the due date," said Sefcik. Assuming that they file an extension and the return is due on September 15, they could go until October 5.
It is a good idea to file extensions, since the IRS checks the name and ID number, according to Olenski. "So filing your extension in March for a calendar-year corporation is a good idea, because then you can know right away whether or not that validation check is going to pass. So then when you ultimately do file the return, you won't be surprised at the last minute."
"If it is an issue, you have plenty of time to resolve it," he added. "You can still go ahead and file on paper, or if you file your extension early enough, you can get it resolved right away."
There will be a change in the number of elections that need to be filed, he predicted. "The Treasury Department has been looking at instructions, looking at regulations, and determining which elections are absolutely required, which ones they may not need right away, or ones that a taxpayer may need to keep in their files," he said. "Traditionally, taxpayers have attached virtually everything to the tax return and then filed that with the IRS. As part of the elimination of impediments to e-filing, regulations that are coming out shortly will require some of those elections and some of those documents to be kept in the taxpayer's files as a separate item that is not going to be filed with the tax return."
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