Monday, September 20, 2010

THE NEW E-FILE MANDATE

Every US citizen and resident is required to file a federal income tax return, regardless of age (a subject for another post), if the individual/couple has gross non-exempt income in excess of a certain threshold, based on the individual’s, or married couple’s, filing status and situation.

An individual with income below the appropriate filing threshold may still need to file a tax return to get a refund of federal income tax withheld, or to claim an Earned Income, Additional Child Tax, American Opportunity or other refundable Credit. And a person may also be required to file a federal income tax return to calculate and pay an additional federal tax or penalty other than income tax.

An individual or couple may engage a tax professional, such as me, to prepare the federal income tax return that he/she/they is/are required to file. While, as is the case with just about every situation where a person or company provides goods or services for compensation, the preparer has certain legal and ethical responsibilities regarding the preparation of the return, the tax pro is hired by the taxpayer to simply prepare the return.

My obligation as a paid tax preparer ends when I complete the return properly and, upon being paid, give the finished return to the client for signature and filing. The taxpayer client is responsible for filing the return. The client may choose not to file the return I have prepared, opting to get a “second opinion” from another preparer if not satisfied with my result, and may actually file a return prepared by another tax professional.

A taxpayer may decide to file his/her/their return electronically instead of mailing a paper return. In order to file electronically most taxpayers must use tax software (although the IRS does offer a Free File program through outside vendors for certain low-income taxpayers with simple returns). A professional tax preparer may have the capability, via the expensive tax preparation software package he/she uses, and by registering as an “Electronic Return Originator” (ERO), to submit returns electronically, and the taxpayer client may request that the tax pro submit the return he/she has prepared electronically as an additional service.

But the bottom line is that the requirement to file a return lies solely with the taxpayer. A professional tax preparer has absolutely no obligation to file a client’s tax return. If a required return is not filed, or filed late or incompletely, it is the taxpayer, not the tax preparer, who is responsible to and penalized by the Internal Revenue Service (although there may also be preparer penalties is part or all of the “incompleteness” is proven to be the fault of the preparer).

As a paid tax preparer the only federal income tax return that I am required to file (and the only return that I actually file) is my own!

What am I getting at here?

Congress passed a law, via an amendment to the Worker, Homeownership, and Business Assistance Act of 2009, that says. “The Secretary shall require that any individual income tax return prepared by a tax return preparer be filed on magnetic media if (i) such return is filed by such tax return preparer, and (ii) such tax return preparer is a specified tax return preparer for the calendar year during which such return is filed”. It goes on to say that, “For purposes of this paragraph, the term ‘specified tax return preparer’ means, with respect to any calendar year, any tax return preparer unless such preparer reasonably expects to file 10 or fewer individual income tax returns during such calendar year”.

The probable intent, and popular interpretation, of this law is that professional tax return preparers are required to submit all returns they have prepared electronically. Presumably if the return is not submitted electronically it is the preparer, and not the taxpayer, who will be penalized. This is wrong!

The text of the law states – “if (i) such return is filed by such tax preparer”. To reiterate what I discussed above, as a professional tax preparer I do not “file” any tax return other than my own. I “prepare” a tax return, and may, as a convenience for and at the request of the client, actually put the signed return in an envelope addressed to the IRS, seal and stamp it, and deposit the envelope in the outgoing mail slot at the Post Office. But the taxpayer client is the one who actually “files” the return. To be sure no “such return” is ever filed me, the “such tax preparer”.

So as I read this law, the requirement to electronically file a federal income tax return that has been prepared by a tax preparer falls on the taxpayer and not the tax preparer.

This is as it should be. If Congress wants federal income tax returns to be filed electronically then the responsibility to do so should fall on the individual whose responsibility it is to actually file the return – the taxpayer.

I certainly understand, and agree with. the reasons why Congress and the IRS, and the state tax authorities, want tax returns filed electronically. It is cheaper and more efficient to process returns that have been submitted electronically. I have no problem with submitting tax returns electronically, although some of my clients do not completely trust the process of electronically filing anything.

Prior to the passage of the federal law many states, New Jersey included, required resident paid tax preparers to file state income tax returns electronically. While I have not counted, I expect that I “submit on behalf of my clients” (I do not file) about 2/3 of my NJ returns electronically. I do it because I can do so free of charge directly on the NJ Division of Taxation website using the state’s NJWebFile system. The 1/3 that are still submitted via postal mail are done so because of the restrictions of the system (all NJ-1040s cannot be submitted via NJWebFile) or because the client specifically does not want me file electronically.

Filing NJ returns electronically, while certainly beneficial to the State of New Jersey, also has a benefit for the taxpayer. Only electronically submitted returns can request direct deposit of a refund – so the taxpayer gets his money quicker. There is really no additional benefit to the taxpayer for filing federal returns electronically, as refunds on paper-filed returns can request direct deposit.

I do not file federal income tax returns electronically because I do not use expensive and flawed tax preparation software to prepare returns. I prepare all my federal income tax returns manually – always have and always will. Tax return software is really the only option for submitting returns directly to the IRS electronically. The current “traditional” FreeFile program offered by the IRS, which I pointed out is extremely limited, and an apparently very flawed “Free File Fillable Forms” option, use outside vendors to submit the return.

If the IRS offered a system for electronically submitting federal returns equal to the NJWebFile system I would gladly, as a convenience for my clients, “submit on their behalf” finished 1040s and 1040As electronically, unless they specifically chose to “opt-out” as they apparently will be permitted to do.

Many states, again NJ included, now require that all business filings and returns be done electronically. The only way to submit these filings and returns, and applicable payments, is online. There are no longer any more paper, for example, WR-30s, NJ-927s, NJ-500s, or ST-50s or 51s. And these states provide a free way to directly submit all filings and payments online. The business is not required by the state to purchase potentially flawed and expensive commercial software.

In these cases the requirement is placed on the individual business owner, and not on the outside accountant or tax professional for the business. As it should be. I gladly “submit” the payroll and sales tax filings and payments for my few remaining business clients via the NJ Division of Taxation website as a service.

So I believe that, as the law is written, I am not required to submit the 2010, and subsequent, federal income tax returns that I prepare for clients electronically.

I am very sincerely interested in the comments of my fellow tax professionals, and especially my fellow tax bloggers (are you listening Annette, Kay, Kelly, Mary, Trish, Bruce, Dan, Jim, both Joes, Russ, etc?) on this post. You can respond “on the record” by submitting a comment, or “off the record” by email to rdftaxpro@yahoo.com.

TTFN

10 comments:

Riles said...

Interesting problem. I appreciate your distinction between preparing and filing. I'm worried it may be lost on Congress though. The Committee report says:

Explanation of Provision

The provision generally maintains the current rule that regulations may not require any person to file electronically unless the person files at least 250 tax returns during the calendar year. However, the proposal provides an exception to this rule and mandates that the Secretary require electronic filing by specified tax return preparers. "Specified tax return preparers" are all return preparers except those who neither prepare nor reasonably expect to prepare ten or more individual income tax returns in a calendar year. The term "individual income tax return" is defined to include returns for estates and trusts as well as individuals.

Mary O'Keeffe said...

I agree with Riles. You make an important distinction between preparing and filing.

(The confusing reference to who is "filing" the return reminds me of the word play in Shakespeare's Much Ado About Nothing in the interchange with the friar about who is "marrying" who. Does the friar marry the bridge and groom or do they marry one another.)

The legal usage of the term "filing" to refer to what the preparer does when he submits a return on behalf of a taxpayer does appear to require more clarification.

Mary O'Keeffe said...

On another issue, I strongly take exception to something else you wrote above.

You wrote: "There is really no additional benefit to the taxpayer for filing federal returns electronically, as refunds on paper-filed returns can request direct deposit."

True, paper-filed returns can request direct deposit, BUT processing of paper-filed returns typically takes four to six weeks, even if direct-deposit is requested on the paper-filed return.

By contrast, the IRS typically processes e-filed returns requesting direct deposit in one to two weeks.

Big difference! Why the big difference? When you submit a paper return, it has to go through the mail, then sit in a bin awaiting an IRS employee to manually retype the information from your return into their system, then presumably some sort of error-checking quality review of that typing and transcription process. It's especially important for the IRS to double-check that they properly typed your bank account information properly during their transcription process. All this takes time. And, of course, there has to be careful oversight to make sure that a rogue employee doesn't type his own bank account information in during the transcription process, etc., etc.

All these kinds of controls are faster to manage electronically.

Robert D Flach said...

MOK-

Thanks for your comments - I always look forward to hearing from you on tax policy topics.

You are correct that electronically filed returns can result in the quicker direct deposit of a refund than a paper return which requests direct deposit. However I have found that the direct deposit of a refund requested on a paper return takes less than 4 weeks.

As I mentioned in the post I acknowledge that "it is cheaper and more efficient to process returns that have been submitted electronically".

TWTP

Russ Fox said...

I've posted a response on my blog at http://www.taxabletalk.com/2010/09/20/it-depends-on-the-meaning-of-the-word-is-is/

The short answer is that I think you're technically correct. The long answer is it could cost you a lot of money to fight this battle.

Elizabeth R., EA said...

I agree with Mary above regarding electronically filing Federal Returns. I am located in Indiana and this year we had the pleasure (?) of dealing with Fresno, California when processing all paper returns. This has been a nightmare. They have lost multiple returns in whole, pieces of returns and in general do not have enough staff to process the volume they saw this year. These are just a small number of our returns that could not be filed electronically for one reason or another.

You do make an interesting distinction in your post. I wonder, do you plan to have all your clients sign the electronic filing opt out that is supposed to be available?

Bruce said...

Well it seems the story is the same in that no one believes you’ll win “the fight/battle” but the consensus is the same, you are right.
Yes the new rules say this is how it will be. But your play on the word isn’t so much play. I mean let’s face it our laws and most covered in our post the tax laws are full of word play and interpretation.
Your interpretation of the wording of this new requirement is just and in my own mind sound. As has been agreed by our colleges.

Sadly I feel as the others. I have mentioned this to you many times in the past in our emails; one quote comes to mind “I don’t think the IRS is going to wait until you retire with 50 years in.” Alas the time just over a year away. Sadly, my friend, “playing the game” is just what you will have to do.
I commend your efforts for exclusion and if I can be of assistance I hope you will call on me. However, even with all the funding you’d need, I fear you’d be penalized for not being compliant. The end result, as stated by Russ, in my mind correct, you’ll then find yourself facing an administrative hearing. As the wheels there are very “large”, you would still need to comply. The big boys would interpret the rules, and their ruling, to their means and way.

Sadly I even fear that this power fight or flight is going to back fire. My thought is, with all the attention you are bringing to yourself over this is a great stand and your voice is being well heard. Everyone is hearing you, and I can see a federal prosecutor even now, piling up a case against you and when all 400 plus of your clients “opt out”, it will be “suspicious” and questionable. Are you ready to put all of your clients through that inquiry? Will they all announce it was their intention not to have their return e-filed, not being coerced by you in any way?
I agree with Joe, as a policy matter, the IRS is out of line on this mandate. I agree with Riles in that this will all be lost on Congress.

I wonder now why more of our colleges haven’t chimed in as of yet. Monica, Kelly, Michael R., Stacie, Trish, Jim, Kay, and a few other Joes, why haven’t you let us know some more. Where are your two cents?

Lastly my friend. As I mentioned last year (or was it just earlier this year?) I have been using software for many of my years as a preparer. I agree on certain fronts it is “potentially flawed and expensive”, however there is software out there that is inexpensive and would suit your needs and allow you to comply with the new coming rules. You would basically prepare your clients returns by hand has you always have, then type your numbers into your software and transmit. In some cases it would help as it would handle state returns as well.

Hey, Mr. Congress person and IRS man. Instead of going at it the you are why not try mandating ERO status, thus prepares being able to offer E-file but leaving the choice up to the individual taxpayer. You make us buy software that depending on the vender charges extra for e-filing services or even extra for the e-filing software on top of prep software. I say Meet us half way will ya’?

Hal Leahy said...

The history of the bill, as well as other bill that were in the hopper at the same time, is interesting as it gets to Congressional Intent. In his comment, Riles provides a quote from a Committee report.

What became the Worker, Homeownership, and Business Assistance Act of 2009, 26 USC 6011, began in the House as H.R. 3548. HR3548 was a bill to temporarily expand emergency unemployment compensation. The return preparer provision was not in the original bill. The provision was added on October 29, 2009 by Senator Reid, on behalf of himself and others. The amendment was Senate Amendment 2712. The provision comes seemingly ‘out of the blue’.

The CRS summary of the applicable section of HR3548 on Thomas states: “(Sec. 17) Requires tax return preparers who expect to file more than 10 tax returns to file such returns electronically.”

At the same time HR3548 was under consideration in the Senate, H.R.3901 the Homebuyer Tax Credit Improvement Act of 2009 was introduced in the House by
Rep John Lewis on October 22, 2009. It contains near identical language to the Reid amendment in the Senate.

The CRS Summary of HR3901 on Thomas states one of the purposes of the bill as: “Requires tax return preparers to file tax returns electronically unless they reasonably expect to file 100 or fewer individual income returns in a calendar year.”

On October 26, 2009, Sen Robert Casey introduced S.1930 The Homebuyer Tax Credit Oversight and Accountability Act of 2009 in the Senate. This also contains language very similar to the language of HR3548. The CRS summary of that bill is: “Requires tax return preparers to file tax returns electronically unless they reasonably expect to file 100 or fewer individual income returns in a calendar year.”

The summaries appear to be using two different meanings of ‘file’. The first ‘file’ is clearly a reference to electronic submission of returns. The second ‘file’ could be interpreted (and probably is going to be interpreted) as ‘prepare’.

Finally, as further evidence that ‘file’ means both ‘submission’ and ‘prepare’ is H.R.4981. The title of HR2981 is “To amend the Internal Revenue Code of 1986 to provide a religious exception to the requirement that certain tax return preparers file returns on magnetic media.” This was introduced by Rep Collin Peterson on March 25, 2010. The CRS Summary of HR4981 is: “) Exempts tax return preparers who object to the use of magnetic media on religious grounds from the requirement to file returns electronically.”

If ‘file’ only meant ‘submit’ as your post suggests then HR4981 is unnecessary since no preparer can be forced to ‘file for any reason. Only the taxpayer would ‘file’. However, if ‘file’ includes ‘prepare’ then HR4981 is necessary to protect the religious scruples of those who prepare returns but do not file them electronically for religious reasons.

On April 4, 2010 Rep John Lewis introduced H.R.4994, the Taxpayer Assistance Act of 2010. HR4994 has near identical language to HR4981. The House passed the bill on April 14, 2010. The Senate referred the bill to the Finance Committee where it remains. If ‘file’ does not include ‘prepare’ then HR4994 would also not be needed.

As Russ wrote on his blog, this will come down to the meaning of ‘is’ – really ‘file’. There is a very good case to be made that by Congressional intent – ‘file’ includes ‘prepare’.

Anonymous said...

I left you a message on the NATP Member to Member site. Proposed Regs say that it will be 'disreputable conduct' to not e-file. I'd hate to see you get thrown out by Circular 230 as soon as you've been covered by it! -Kevin Huston, EA

Anthony said...

"the requirement to file a return lies solely with the taxpayer"

Actually, the requirement in the law lies solely with the Secretary. So I'd say the distinction is irrelevant.

The requirement for preparers to obey the regulations which are passed by Secretary likely lies elsewhere in the law, though I don't have an opportunity to find it right this instant.