The infancy of e-taxes

There's no doubt online tax returns are taking off, but where are they headed?

When Paul Bettencourt was elected tax assessor/collector of Harris County,

Texas, in 1998 — partially on the strength of his campaign pledge to put

the agency online — he inherited an office that seemed an unlikely candidate

for cutting-edge technology.

Long-established tax-collection traditions, decades-old office equipment,

and a nearly complete lack of financial and IT infrastructure made the notion

of moving the office into the Internet Age seem laughable.

But the need to improve the accuracy, security and simplicity of collecting

more than $2 billion in taxes each year proved a good incentive. After intensive

development, the office's e-tax effort succeeded: The county accepted its

first online property tax payment by credit card in October 2000.

"We got into the 20th century just as it was ending," Bettencourt said.

Although far from typical, the Harris County effort is representative

of the newest trend in electronic tax collection. Faced with a deluge of

paper forms and the need to collect and track enormous amounts of money,

many state and local revenue departments are exploring ways of using the

Internet to simplify the filing process and speed the collection of various

types of taxes.

Since its launch, Harris County's system has been responsible for the

collection of $3.6 million in property tax paid online by credit card — a dollar volume that exceeds the total amount of taxes collected by 10 of

the Tax Office's 14 branch locations. The higher-than-expected volume represents

about 1 percent of all tax payments during the system's first three months.

"We thought we'd do about a million and a half during the first year,

but the system has been so successful, it's like adding a virtual branch,"

Bettencourt said.

With the system's launch, Harris County became the only tax authority

in the nation to offer online programs for both property tax payments and

auto registration. The office is responsible for 3.5 million auto registrations

and 1.5 million tax accounts.

About 18 states and a handful of local governments offer Internet-based

electronic filing for personal, property or business taxes.

Taxpayers in 22 Kansas counties, for example, paid approximately $225,000

in property taxes online via their personal checking accounts during the

state's November-December tax session. The online property tax program was

launched Nov. 1 by the Kansas County Treasurers Association, and is slated

for expansion this year with the participation of additional counties and

an option to pay via credit card.

The rise of online tax systems has its roots in the federal e-file program

for individual income tax returns, launched by the Internal Revenue Service

in 1987 and expanded four years later to include electronic filing of state

returns. By allowing states to piggyback on federal returns, the IRS' expanded

Federal/State e-file program has given states a relatively inexpensive

means of introducing e-filing, often with impressive results.

"We have done a lot of work in partnership with the IRS, and our program

uses the same protocol as the federal program," said June Summers Haas,

Michigan's Commissioner of Revenue. In 1999, Michigan processed about 900,000

personal income tax returns with the e-file program and an additional 150,000

through its telefile system.

"We can process returns more quickly, we have quicker turnaround of

refunds and we can spend less staff time on data entry. That allows us to

free up our staff to do more affirmative customer service," Summers Haas

said.

In keeping with the most widely accepted approach to online tax collection,

Michigan relies entirely on traditional tax preparers for the transmission

of e-filed returns.

"Right now, we only allow electronic filing through tax preparers. We

have not implemented Internet filing yet," Summers Haas said. "We're following

the lead of the IRS."

E-filing vs. Internet Filing

The traditional Federal/State e-file system requires taxpayers to use

an "electronic return originator" — typically software from a professional

tax practitioner, such as Intuit Inc.'s Turbo-Tax — to prepare a return

on a PC. the taxpayer submits the return to the company, which then submits

the return to the taxing authority.

In the online model, the taxpayer prepares the return electronically

with the assistance of a commercial Web-based tax-filing service — such

as H&R Block's Online Tax Program — which also acts as the e-file "transmitter"

by sending the finished return to the taxing authority. The Internet filing

service provides the taxpayer with increased control over the reporting

and payment process and works with the tax authority to provide accurate

data and fast transfer of payments, which are typically charged to the payer's

credit card.

Internet-based systems are currently in the minority. And the

success of the initial e-file implementations, coupled with pressure from

private tax practitioners, has spurred widespread adoption of the Federal/State

e-file model.

The support of professional preparers has led to impressive adoption

rates even in states that have only recently launched e-file programs. Ohio,

for example, topped the 1 million mark for tax returns filed by computer

or phone in 1999, the first year that the state began accepting electronic

returns.

California has taken a hybrid approach to the e-file vs. Internet-file

decision. Following a successful pilot of its traditional e-file program

in 1994, the state began to accept returns filed by Web-based tax services

in 1998. Last year, California processed more than 2 million personal income

tax returns electronically, including 1.6 million generated by tax practitioners

and 457,000 from individual taxpayers, according to Patrick Hill, a spokesman

for the California Franchise Tax Board.

Participation in California's e-file program has nearly doubled each

year since it was first offered statewide in 1995, while the number of filers

using the state's telefile option has remained static at approximately 260,000,

Hill said. Last year's combined e-file and telefile returns represent about

15 percent of California's 14.5 million personal income tax filers — which

puts the state well on the way to its goal of processing a majority of its

personal income tax returns without paper by 2010.

The drive toward greater e-file participation is fueled by the benefits

the state reaps in time and dollars saved. In a survey conducted during

last year's tax season, the state found its cost of processing a balance-due

e-file or telefile return is about 55 cents — roughly a third of the cost

of processing a similar paper return, Hill said.

"The accuracy of electronic filing reduces or eliminates our need to

contact taxpayers. It's easier and less expensive for us to process electronic

returns because paper returns have a higher probability of error," Hill

said.

Next Horizon: Business

Buoyed by successful personal income tax return systems, many states

are expanding their electronic filing offerings to include e-filing of business

and other taxes.

But with their reliance on Internet front ends, increased taxpayer participation

and closer cooperation with online tax-filing companies, the new systems

often bear little resemblance to their predecessors.

In theory, business tax e-filing should be a much easier sell than personal

income programs because of the greater complexity of reporting and calculating

levies such as sales or license taxes. And businesses have to file and pay

more frequently than personal filers. But even in states that have launched

successful online business tax-filing systems, the benefits of convenience

and online accessibility don't always translate into widespread adoption.

Launched in October 1999, South Dakota's SD Quest (Quick Easy Secure

Tax Filing) online business e-file system processed 18,893 returns and collected

$173 million in sales, use and contractor's excise taxes during its first

year. Renaissance Government Systems developed the system.

The state collects 34 percent of its tax revenue electronically, even

though the SD Quest system is used by only about 4.5 percent of its taxpayers.

"Usage patterns have been what we expected, but less than what we'd

hoped for," said Scott Peterson, director of South Dakota's Business Tax

Division. "To make this really successful, we need to get the smaller payers,

and that's difficult because this is not what the average taxpayer is used

to doing."

Growth in the number of users has been strongest during periods when

the state has aggressively marketed the system, Peterson said. Drawing on

the success of initial focus groups with business users and associations,

the Business Tax Division has conducted seminars throughout the state and

plans a new round of sessions this spring.

"This isn't the field of dreams," Peterson said. "Just because you

build it, that doesn't necessarily mean that they will come. You have to

give users a good reason to change their way of doing business."

To provide business users a risk-free incentive to try its new Web-based

filing option, Delaware is underwriting the transaction fee costs for the

system's first year. Users have responded well to the incentive so far,

and the state is on track to meet its first-year participation goals, according

to David Sullivan, a representative of the Delaware Division of Revenue.

The success of the state's internally developed personal income e-file

program inspired Division of Revenue planners in their search for a simple,

secure way for companies to electronically file business taxes. For the

actual implementation of its business tax system, however, the state turned

to an external vendor, the Birmingham, Ala.-based Internet tax-filing company

Nationtax Online Inc.

"We were looking for a company that could provide us with a solution

very quickly," Sullivan said. "Speed and cost were primary considerations,

and with so many people having access to the Internet, we felt it was a

necessary and logical step to support Internet filing for business taxes."

Nationtax offers online preparation, filing and payment of business

taxes such as sales, use, corporate income and personal income tax withholding.

In addition to Delaware, the IRS and a number of states — including Florida,

Hawaii, Idaho, Louisiana, Pennsylvania and Rhode Island — have adopted the

company's Web-based business tax filing application. The company has processed

more than $200 million in Web-based tax payments since July 1999.

In a typical scenario, a business taxpayer accesses the Nationtax network

online, selects the appropriate form and completes the necessary filing

information. The Nationtax application then transmits the return to the

tax authority and arranges for any payment to be transferred from the user's

bank account. The service is funded through a transaction fee, typically

$3.95 for most filings.

"Governments get clean data, and the money is automatically deposited

into [taxpayers'] accounts," said Rhonda Jung, Nationtax public relations

manager. "They don't have to deal with all those paper forms, and they don't

have to process paper checks."

Web-based systems provide a particularly welcome solution for business

filers in the six states that allow counties and cities to "self-collect"

their own taxes.

In Alabama, for instance, companies doing business throughout the state

face the challenge of calculating sales taxes for as many as 453 taxing

jurisdictions, in addition to the state's own sales tax. Through its AlaTax

Inc. division, Nationtax provides outsourced tax collection for 92 cities

and counties in the state, enabling business filers to prepare, file and

pay about 300 of those taxes in a single filing.

"Some businesses have told us that they have two people in their tax

department — one for Alabama and one for the rest of the country," said

Andrea Hunter, the company's vice president of product management. "We make

the process simpler for taxpayers and for the governments."

Walsh is a freelance writer based in Peekskill, N.Y.

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