The Internal Revenue Service may not reach the 80 percent e-filing goal for the 2007 fiscal year set by Congress in 1998, but it continues to advance with the help of improved technology, wider perception of its benefits, and both state and federal mandates for taxpayers and preparers.Last year, more than 73 million tax returns were filed electronically - nearly 54 percent of all tax returns - while the Free File Alliance, a partnership between the IRS and software vendors, continues to help drive taxpayers toward e-filing, serving about 4 million individuals last year. This year, the program has been expanded, with 70 percent of taxpayers - those with an adjusted gross income of $52,000 or less - now eligible.

"The benefits are beginning to be appreciated. Its efficiency, accuracy and timeliness have paid off," said Dan Meehan, tax partner at New York area firm J.H. Cohn.

KEEP YOUR FINGERS CROSSED

The first month of e-filing season, which began on January 12, was relatively free from glitches, according to observers.

"So far it's going very well," said Teresa Mackintosh, vice president of marketing for tax software publisher Creative Solutions. "A few states are accepting corporate or partnership returns for the first time, and some of them are not hitting their target date to be ready. It's typical for first-timer states to have some problems."

"We're currently 10 percent ahead of last year in volume," she reported. "We're seeing positive trends for both GoSystem RS and UltraTax CS."

"A lot of new states are coming on board with business returns," said Rebecca McCaulley, manager of electronic filing systems for CCH's ProSystem fx. "We're working on a joint program where we can send the state and federal return to the IRS and the state picks up the state return from the IRS."

"The biggest challenge for us was when the IRS decided to change the due date for everyone to April 17," she said. "The problem is that a lot of things have to be updated in the software - when the client has to file and penalty calculations, for example. And some states won't be able to conform. They didn't know in advance of when the IRS announced it to the public, and they had to scramble to figure out whether their tax law says they will have the same date as the federal system or will be the 15th or 16th."

"There are no glitches yet," said J.H. Cohn's Meehan. "Our problems have been held to a minimum - the only issue is to follow up with clients who have not gotten back the authorization to e-file, and communicate the deadlines."

"Our experience has been good," he continued. "Once you get through the set-up, the process itself makes things go much more smoothly. It's more efficient, faster, and you get fewer notices from the tax authorities. As the technology improves and we move toward a paperless operation, e-filing will fit perfectly."

Meehan said that the firm's individual clients still get a paper copy of their tax return, while businesses are given a CD.

It will still take time before everyone favors it, he said. "The problem is to get the dinosaurs to accept it," he said. "As a tax partner, it helps me, because I don't have to physically examine every return. I can open them up electronically. It saves us money and allows us to do better service for our clients."

Roger Harris, president of Padgett Business systems, agreed. "Eventually, it's a matter of changing people's behavior and patterns," he said. "Just like online banking services, it will become a matter of routine. We'll see demand for it as taxpayers get younger. Senior taxpayers have to be coaxed into it."

"Clients typically don't resist what a person preparing their return says is best for them," he noted. "There's an answer to most objections to e-filing. They come to us for advice, so why would they resist that advice when we tell them to e-file?"

Jorge Olivarietta, senior product manager for Lacerte, expects a significant increase in volume. "In the last few years, the driving force was that accountants saw e-filing as a way to increase their productivity," he said. "As they become more familiar with the process and get oriented toward a paperless workflow perspective, they don't want paper for some returns and paperless for others. Also, mandates created a surge in e-filing for individual returns, and we're starting to see something similar on the business side as mandates expand into that arena. This is the first year that modernized e-filing has been available for partnerships."

MEF

Modernized e-File, also known as MeF, is a Web-based system that allows electronic filing of corporate and tax-exempt returns through the Internet using the Extensible Markup Language format, or XML, a standardized way of identifying, storing and transmitting data.

This year, partnerships have the option of filing using the existing Form 1065 e-file system or the Modernized e-File system. For partnerships filing Form 1065-B (electing large partnerships), the form is available only through Modernized e-File. Partnerships with 100 or more partners must file electronically, and beginning in January 2008, Modernized e-File will be the only e-filing platform available to e-file partnership returns.

But the transition from paper to electronic filing for business returns has not been entirely smooth, say observers. "There were hurdles last year because it was such a large change in the process," said Donna Castellano, senior product manager for software maker Vertex.

"Electronic filing requires a specific format, whereas in the paper world you have flexibility," she explained. "A midsized corporation might have hundreds of subsidiaries, and you have to get financial data and consolidate it to one return. A lot of election statements, attachments and additional information are necessary, not just the tax form. Getting all these into an XML format requires a big learning curve."

Last year's mandate required corporations with assets of $50 million or more to start e-filing their 2005 Forms 1120 or 1120S. This year, the threshold has dropped to $10 million for corporations that file 250 or more federal returns a year. Since "federal returns" includes excise tax, employment tax and information returns such as Forms W-2 and 1099, most corporations that meet this threshold are covered.

"Even though they file electronically, there will still be a paper process," said Castellano. "The IRS has to catch up and teach auditors how to audit an e-filed return. Most corporations have an electronic filing cabinet with printable copies, because XML is essentially a hard-to-read data dump. It's a technology change that's transitioning slowly into the future."

Dan Gooding, an income tax specialist at InSource, Thomson's Web-based solution for corporate tax, agreed. "When the auditor asks to see a copy of the return, will he be looking at an XML file? The client is still going to have a paper copy."

"With the mandate dropping from $50 million to $10 million, we'll see a lot more CPA firms having to deal with e-filing of 1120 returns," he added.

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