EXECUTIVE SUMMARY
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The trend toward e-filing continued in 2007, with tax practitioners and individuals preparing their own returns e-filing a record number of nearly 80 million returns, accounting for over half of the returns received by the IRS.
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Beginning with 2007 returns, practitioners must use the self-select PIN or the practitioner PIN method for signature verification for electronically filed returns.
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Beginning in 2008, nonfiling small tax-exempt organizations (less than $25,000 in gross receipts) are required to e-file Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990, or 990-EZ.
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Authorized IRS e-file providers, including EROs, that obtain taxpayer information by the internet directly or through third parties in order to prepare or e-file returns are now required to register their websites.
2007 was another record-breaking year for tax returns filed electronically with the IRS. Of the 139.3 million returns received by the IRS in 2007, just under 80 million were e-filed. That represents 57.4% of all returns filed in 2007. Compare that to a decade ago, when only 15.8% of the total returns were e-filed.1
It is not just tax practitioners that have helped increase those numbers. While tax practitioners account for 57.4 million electronic returns, the remaining 22.6 million submissions came from individuals preparing their own returns, either through the IRS Free-File program or with user-friendly over-the-counter tax software programs that offer electronic filing as part of the package.
Part of the increase in e-filing is due to IRS and state mandates requiring electronically filed returns for business and individual returns.2 Although many practitioners were already voluntarily participating in the e-file program, the mandates have forced others to get started. Now, those practitioners are not only e-filing the required returns, they are e-filing many others as well, including extension forms. The benefits of e-filing are becoming well known to practitioners, prompting them to more readily embrace the concept. Benefits include:
Cost savings: E-filing uses less paper and less ink toner, and it saves on wear and tear on office equipment. There is also a potential saving in personnel time, including less time spent on trips to the post office and processing certified mail requests.
Confirmation of receipt and acceptance of returns: Once a return is transmitted to the IRS, an acknowledgment of receipt and of acceptance or rejection is returned to the transmitter within 48 hours. Notification is received if a return is rejected along with an explanation. If the discrepancy can be corrected, the return can be re-transmitted up to the later of the due date or five days after the rejection notification. If the rejection cannot be corrected, a paper return must be submitted by the later of the due date or 10 days after the rejection notification.
E-filing eliminates postage and return-receipt requests. It also eliminates post office visits on deadline days and waiting in long lines to obtain a stamp for proof of timely mailing. E-filing assures practitioners and taxpayers that returns have been filed timely. Also, error detection related to Social Security number or name discrepancies is performed on transmission to the Service. These errors can be corrected immediately instead of receiving a tax notice months later.
Accuracy: Paper returns are keypunched into the IRS and state systems by data entry personnel, which can lead to transcription errors and subsequent tax notices. E-filed returns are imported directly into the IRS and state systems, eliminating those types of errors. According to the IRS, the error rate for e-filed returns is less than 1%, compared with 20% for paper returns. E-filing results in faster processing (with fewer processing errors), and therefore faster refunds, especially when using the direct deposit feature.
Security: Each electronic return originator, software developer, and transmitter must submit an application to the IRS and pass a suitability background check. Transmittersand software developers are also subjected to annual testing for security and compatibility standards. The number of people physically handling the returns is greatly reduced.
The exhibit3 on p. 227 shows the start-to-finish flow of a paper tax return and the steps that are eliminated when the return is filed electronically. With current fiscal conditions, it is little wonder that government agencies are strongly encouraging electronic filing. The cost savings to these agencies are tremendous. The need to hire large numbers of temporary workers during tax season is greatly reduced, follow-up notices due to data entry errors are reduced, and physical storage space requirements are much lower.
Electronic Return Originators: Roles and Responsibilities
An electronic return originator (ERO) is an authorized IRS e-file provider that originates the electronic submission of tax returns to the IRS. An ERO can be a sole proprietor, partnership, corporation, or other business entity. To become an ERO, a practitioner must submit an IRS e-file application. This can be done through the online e-services section of the IRS website.4 Preparing the application online is more efficient, as the preparer can be notified immediately of common mistakes made to the application. Errors made on a paper application, on the other hand, can cause lengthy delays in the approval process. However, certain documentation may need to be submitted separately by paper, such as fingerprint cards and copies of CPA licenses or state bar cards. Background checks may be run on the business entity and principals, including criminal background, credit history, and tax compliance checks.
A practitioner who is accepted as an authorized IRS e-file provider has certain responsibilities, including (but not limited to) the following:5
- Update the IRS e-file application in a timely manner for any changes that occur. These include, but are not limited to, contact information changes, ownership changes, and the addition of a new set of forms to be e-filed. This updating can be done online.
- Ensure the security of the tax return information, electronically transmit returns in a timely fashion, and submit any required paper documentation. For example, an appraisal may be required to support a noncash donation reported on Form 8283, Noncash Charitable Contributions, or a detailed brokerage statement of gains and losses may be required to support information summarized on Schedule D, Capital Gains and Losses.
- Provide copies of tax returns to taxpayers and obtain required taxpayer signatures on the applicable forms that authorize the ERO to electronically transmit the return. These forms must be received prior to transmission.
- Retain signature forms, by paper or electronic copy, for at least three years.
What’s New for 2008
PIN Signature Method Now Required
Prior to the 2008 tax filing season, practitioners e-filed individual income tax returns using either Form 8453, U.S. Individual Income Tax Transmittal for an IRS e-File Return, or Form 8879, IRS e-File Signature Authorization. Taxpayer signatures were obtained on Form 8453; once the IRS accepted the return electronically, the form was mailed to the IRS for signature verification. With Form 8879, which uses the PIN signature method, taxpayer signatures are obtained and the form is kept by the ERO for three years. This is the truly paperless method for e-filing with the IRS. The IRS accepts signatures using either the self-select PIN method or the practitioner PIN method. Under the self-select method, a taxpayer enters his or her PIN (any five-digit number) onto the ERO’s computer. This method requires the taxpayer’s date of birth, prior-year PIN, and prior-year adjusted gross income (AGI). Under the practitioner PIN method, the ERO enters a PIN on the taxpayer’s behalf. Date of birth, prior-year AGI, and prior-year PIN are not necessary when using this method.
Most practitioners use the practitioner PIN method because it is easier, and it may not be practical to have taxpayers enter information onto the ERO’s computers. When using the practitioner PIN method, the taxpayer signs Form 8879, authorizing the ERO to enter a PIN on the taxpayer’s behalf. The signed form must be retained by the ERO for three years. The IRS performs surprise visits to selected firms throughout the year to inspect the signed forms.
Beginning with 2007 tax returns, the IRS requires all electronically filed returns to use either the self-select or practitioner PIN method. Form 8453 is no longer accepted as a signature verification form. The form, which was revised for 2007, will be used only as a transmittal form for certain documents that are required to be submitted. The signature lines have been removed from Form 8453. The form now lists certain documents that should be attached, including Form 8283 for noncash charitable contributions that require a signature and an appraisal. Schedule D-1, Continuation Sheet for Schedule D, would also be attached to this form. Many practitioners will attach brokerage firm detailed gain/loss statements as a substitute for Schedule D-1, rather than enter each individual transaction into the tax software. These substitute forms will be accepted as an attachment to Form 8453.
New Filing Requirement for Small Tax-Exempt Organizations
One of the most notable changes for 2008 is the requirement for small tax-exempt organizations, those with less than $25,000 in gross receipts, to e-file Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990, or 990-EZ. This change was enacted as part of the Pension Protection Act of 2006, P.L. 109-280 (PPA ’06). Information included on the e-postcard will include the following:
- The entity’s legal name and mailing address;
- A website address, if one exists;
- The name and address of a principal officer; and
- A statement confirming that the organization is exempt from the filing requirements under Sec. 6033(a)(1) (i.e., the organization’s annual gross receipts are normally not more than $25,000).
The PPA ’06 requires the IRS to automatically revoke the tax-exempt status for entities that fail to file the notice for three consecutive years (Sec. 6033(j)). Once tax-exempt status is revoked, the entity will have to go through the entire application process again in order to regain tax-exempt status. At the IRS’s discretion, reinstatement may be retroactive to the date of revocation if the entity can show reasonable cause for failing to meet the notice requirement. Churches, their integrated auxiliaries, and conventions or associations of churches are exempt from the notice requirement, as are entities included in a group return and private foundations required to file Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation. The IRS is working on developing a system to allow simple and free electronic submission of the e-postcard.
Other Notable Changes
Website registration: A new IRS e-file rule was released July 30, 2007, requiring ERO website registration with the IRS.6 The purpose of this new rule is to aid in identifying fraud schemes, including phishing. The new rule applies to authorized IRS e-file providers, including EROs, that obtain taxpayer information by the internet directly or through third parties in order to prepare or e-file returns.
Registration is performed by submitting an Excel spreadsheet that contains the following information:
- The e-file provider’s electronic federal identification number (EFIN) as assigned in the e-file application process;
- The name of a principal or responsible official as shown on the e-file application; and
- The URLs of all websites that the provider uses to e-file federal returns, that are portals or allow access to the provider’s online e-file software, or that are used to obtain taxpayer information needed to prepare or e-file a return.
The Excel file must be encrypted using WinZip 9.0, password protected, and e-mailed to efileurlreg@irs.gov.
ERO signatures: In October 2007, the IRS released Notice 2007-79, which allows EROs to sign certain forms by rubber stamp, mechanical device, or computer software program. The applicable forms include Form 8453, Form 8879, and Form 8878, IRS e-file Signature Authorization for Form 4868 or Form 2350. This notice was effective October 15, 2007.
Electronic funds withdrawal: Also new with the 2007 tax filing year is an improvement of the electronic funds withdrawal (EFW) feature. In prior years, if a balance was due on a return and EFW was used, only the tax balance could be transmitted. Penalties and interest could not be included, which caused a subsequent tax notice to be sent to the taxpayers for the remainder. With the improvement, penalties and interest can now be included with the payment.
PIN method for Form 1041: For Form 1041, U.S. Income Tax Return for Estates and Trusts, the PIN method will now be used, along with Form 8879-F, IRS e-File Signature Authorization for Form 1041, rather than Form 8453-F, U.S. Estate or Trust Income Tax Declaration and Signature for Electronic Filing. Similar to Form 8879 for individual returns, Form 8879-F is retained by the ERO for three years. No paper forms are submitted to the IRS.
New forms can be e-filed: Beginning in 2007, amended returns from the Forms 1120 and 1065 series for the 2005 tax year and forward can be e-filed. The IRS will also accept an e-filed superseding return of a previously filed return, provided the return due date has not already passed. For tax years ending on or after December 31, 2006, if the taxpayer was required to e-file the original return, then the amended or superseding return must also be e-filed. However, certain carryback claims are exempt from the e-file requirement and should continue to be filed by paper.
Required corporate e-filing: The e-filing mandate threshold for corporations has been reduced to include corporations that have total assets of $10 million or more and that file at least 250 returns during the year, including Forms W-2 and 1099. Tax-exempt organizations with the same criteria must also file electronically. Private foundations and charitable trusts that file 250 returns or more must file electronically, regardless of their asset size.
Magnetic media: In an effort to get information returns, such as Forms W-2, 1099, and K-1, submitted electronically, the IRS is eliminating magnetic media submissions. Three-and-a-half-inch diskettes are currently no longer accepted, and tape cartridges will not be accepted after December 1, 2008.
Conclusion
With reduced thresholds and the other new mandates, we can expect to see another record-breaking e-filing year in 2008.7 Those practitioners who have been steadfastly resisting electronic filing will face continuing pressure to get on board. Not only are government agencies strongly encouraging it; more and more taxpayers, who are more technologically advanced today than ever before, are expecting it.
For more information about this article, contact Ms. DaLomba at ldalomba@kahnlitwin.com.
Notes
1 IR-2007-185 (11/7/07).
2 See www.irs.gov/businesses/corporations/article/0,,id=146959,00.html for current corporate mandates in effect. See www.taxadmin.org/fta/edi/ecsnaps.html for state mandates currently in effect
3 Illustration provided by the Internal Revenue Service.
4 See “e-Services—Online Tools for Tax Professionals,” www.irs.gov/taxpros/article/0,,id=109646,00.html.
5 See IRS Publication 3112, IRS e-File Application and Participation, for a more extensive list of roles and responsibilities.
6 See www.irs.gov/efile/article/0,,id=172577,00.html.
7 Early returns showed a 5% increase in e-filing for 2008 (IR-2008-32 (3/4/08)).
