IRS e-filing plans getting second look

The Internal Revenue Service is re-examining whether to allow citizens to file income taxes directly online, a move that has raised the ire of tax preparation software companies and their supporters on Capitol Hill.Those who file federal tax returns must purchase or pay a fee to use software or online services from one of a dozen companies that provide the service through the "e-file" partnership with the IRS, said Terry Lutes, director of the agency's Electronic Tax Administration.Companies that provide these e-filing services, such as Intuit Inc. and H&R Block Inc., contend the IRS would be getting into the tax preparation business ? and clearly overstepping its responsibilities if it installed software that allowed citizens to file taxes directly.Nevertheless, the IRS is considering direct e-filing for individual taxpayers and tax professionals as part of the EZ Tax Filing project, one of the Office of Management and Budget's e-government initiatives started last fall. Lutes, who is overseeing the EZ Tax Filing project, said the IRS is looking at a number of ways to make electronic filing easier for the taxpayer. His staff prepared several business cases that address direct filing and other approaches to expand and simplify electronic filing. However, he said internal discussions were ongoing, and there is no formal deadline by which the agency must prepare its recommendations. The IRS has set an internal goal for the agency to have 80 percent of all tax and information returns filed electronically by 2007.Some lawmakers, however, oppose plans to allow direct e-filing. Led by Rep. Randy Cunningham, R-Calif., eight GOP house members last month told the White House that the EZ Tax Filing project should not include tax filing and preparation by the government."As you know, income tax preparation software and interactive online preparation is a well-established, nongovernmental, commercial activity," the lawmakers said in their Dec. 3 letter. "We see no compelling reason for the federal government to compete in this field, where the private sector has succeeded in making electronic tax preparation and filing easy, accessible and affordable for taxpayers."Their arguments echo the position of tax preparation software companies: The government, by providing online e-filing capability, is competing with companies already delivering this service. The companies also say there is an inherent conflict of interest when the government provides tax preparation services for citizens, while at the same time trying to collect taxes from them. "The IRS has considered allowing tax preparation on its Web site, but this is already happening effectively in the private sector, and there is no need for the federal government to duplicate those services," said Julie Miller, a spokeswoman for Intuit, Mountain View, Calif., which has about 70 percent of the market for software used by practitioners and individual taxpayers.The issue of direct e-filing is an important one for systems integrators. Lutes said if the IRS decides to allow direct e-filing, then it would need the services of an integrator to reconfigure its systems. The integrator could be Computer Sciences Corp. of El Segundo, Calif., which holds the IRS Prime Integration contract, or a different integrator as part of a separate project, he said. But Lutes also sought to assuage tax software companies, saying, "These companies will continue to play a role, no matter what the IRS does."That's because the tax preparation software companies serve as a third party responsible for transmitting electronic returns via the Internet for citizens, tax professionals and businesses. Indeed, the federal government and the states have an e-filing partnership in place whereby individuals and tax professionals can submit both federal and state returns in 35 of the 42 states that require residents to pay state income tax. The companies are approved by the IRS to transmit federal forms as part of its e-file program. But if the IRS decides to provide a direct e-filing capability on its Web site, the agency will be pressured by industry to limit the functionality of the tax filing application. And that will require IRS officials to draw a careful distinction between tax filing and preparation."That would be the toughest issue to resolve," Lutes said.He noted that tax software products go beyond helping users prepare returns to actually providing financial advice, which, he said, "is not a role the government should ever play." Thus, the government will never try to supplant the tax companies in helping citizens prepare and minimize their taxes.P.K. Agarwal, the former chief information officer for California's Franchise Tax Board, agreed with this assessment. The software tax programs sell well with people and tax professionals because they offer practical advice, strategic guidance and tax optimization, he said."These companies invest tens of millions to develop these software programs and tax guidance, and governments aren't going to invest this much into it," said Agarwal, now CIO and executive vice president for e-government applications at National Information Consortium Inc., Overland Park, Kan.As a matter of good public policy, all governments eventually will have online tax forms and applications that provide basic arithmetic and check to see if all required fields of entry are completed, Agarwal said."But that's where it will stop, and that won't impact the business of tax software companies," he said.XXXSPLITXXX-Electronic filing at the federal level includes filing by telephone and computer filing by tax professionals and individuals. The Internal Revenue Service estimates 45 million of the 132 million Americans who will file during the 2002 tax filing season will use one of these three electronic methods. During the 2001 filing season, 40.2 million Americans filed electronically, while during the 2000 filing season, 35.4 million Americans filed electronically, according to the IRS.Of the 40.2 million taxpayers who filed electronically during the 2001 season, 4,419,000 were TeleFile returns, 28,989,000 were electronic returns by tax professionals and 6,836,000 were electronic returns by individuals, according to the IRS. XXXSPLITXXX-While those who file electronic tax returns with the federal government must do so with authorized third-party "e-file" providers, this is not the case at the state and local level. Sixteen states and Washington, D.C., offer citizens the choice between filing electronically using commercial software products or filing their returns online with no intermediary.In Virginia, for example, the state conducted a direct-filing pilot program during the 2001 tax season that was used by 20,426 residents. The Web site was established without any promotion, said Robert Schultze, assistant commissioner for the Virginia Department of Tax Administration.The application was developed for Virginia as part of an ongoing tax modernization project by American Management Systems Inc. of Fairfax, Va.This year, the state will promote direct filing ? not to compete with tax preparation software, but to make inroads into the large number of residents who still file by paper, Schultze said. About 105,000 Virginians are expected to file their returns electronically during tax season 2002, he said.Direct filing is only for full-time residents, not for those with partial or uncommon credits, Schultze said. Including these filers would have made the application more costly and complicated. Virginia is one of 35 states that allow resident taxpayers to file through a joint federal-state electronic filing mechanism known as ELF, an abbreviated expression for electronic filing. Citizens can transmit their returns through ELF by using software or a Web site established by third-party transmitters, such as Intuit Inc. of Mountain View, Calif., or H&R Block Inc. of Kansas City, Mo.Schultze said he doesn't believe the state is competing with tax preparation software companies. In fact, more than two-thirds of the electronic returns filed in Virginia during tax season 2001 were submitted through ELF. "We think the federal choice is what dominates which [software] people choose," Schultze said. Even with an increase in direct filing, the ELF process will remain the dominate electronic channel for electronic filing of Virginia returns, he said."There is no doubt there is a future for tax software companies with us. They are our largest electronic filing channel because of piggybacking [with the federal income tax return]," Schultze said.