E-Commerce Tax Preparation- A Conceptual Value Chain

The following white paper is being published for the benefit of anyone looking for information on the state of e-commerce within the context of tax preparation. It gives insightes to current issues, trends and business opportunities for software development, tax professionals and the B2B market.

E-commerce tax preparation
A conceptual value chain: considerations of opportunities and implications

Rene Velez, CPA
13020 SW 133rd Court
Miami, FL. 33186


Copyright 2006
All rights reserved


E-commerce Tax Preparation
A conceptual value chain: considerations of opportunities and implications

The advances of information communications technology together with the affordable transactional costs of e-commerce, have created a proliferation of market opportunities for e-commerce applications across the business spectrum. The accounting profession for many years has benefited from the use of technology in creating efficiencies. Today, through e-commerce applications, technology continues to create efficiencies in the processing of information and is also transforming the accounting profession in both, the services it renders to its clients, and in the way those services are performed. The subject matter of this paper has two relevant perspectives, in relation to e-commerce tax preparation. How tax preparation services are evolving, together with issues and concerns during this evolution. This will be accomplished firstly, by examining a possible interpretation of the value chain of tax preparation and make note, of possible and existing market opportunities for e-commerce applications and business process outsourcing. Secondly, by taking into consideration professional, regulatory, legal, and other social and political issues concerning tax preparation in an e-commerce , e-government (Lassman 2002) expansionary era. To summarize, e-commerce is an effective tool that can be utilized for the benefit of society. However, as noted by Lassman (2002) we should be cognizant that e-commerce opportunities, in relation to tax preparation, have a pervasive effect not only the accounting profession, but also on governmental structures, businesses and individuals.

Prelude to Value Chain Analysis

E-commerce is defined as:
“the use of electronic transmission mediums (telecommunications) to engage in the exchange of , including buying and selling , of products and services requiring transportation, either physically or digitally, from location to location” (Greenstein, M., Vasarhelyi, M . 2002 Electronic Commerce – Security, Risk Management and Control 2nd Ed., chap. 1)

The term e-commerce as used in this paper is intended to be comprehensive to include e-business which includes other business functions such as the exchange of information, and operations which are performed electronically.

The conceptual model of tax preparation offered here is intended as a model to consider potential and existing e-commerce opportunities. There could be many varying paths to deconstruct (Greenstein, Vasarhelyi 2002) the value chain of tax preparation. The deconstruction or unbundling (Ge, Konana & Tanreverdi 2004) process itself, in the context of tax preparation, may need to consider such issues as what potential market is to be served. For example, government versus private businesses and individuals. Perhaps the type of tax return that is being prepared. Whether or not the components of a deconstructed value chain or unbundling (Ge, et al. 2004) of business processes, are economically viable and sustainable, would take many further explorations to determine. These considerations will not be discussed as part of this paper as these considerations are outside the intended scope. Instead we portray a simple model that will allow the reader to form a thought process in relation to e-commerce applications for tax preparation.

A Theoretical Tax Return Preparation Value Chain

Assuming the following are deconstructed components of the tax preparation value chain, how can e-commerce be used to create new business opportunities?

Value Chain Components

1. Gather taxpayer information.
2. Research and analysis of tax laws.
3. Input of information into correct form(s).
4. Tax return(s) preparation and assembly.
5. Collection, payments or refunds of tax(s).

We should first consider some of the traditional goals or enhancements in the electronization (Greenstein, Vasarhelyi 2002) of business processes. Traditional goals have centered around operational efficiencies. Efficiencies that created savings in labor costs, reduced processing time and higher rates of accuracy (Anderson, Fox & Schwartz 2005). However, bitable (Ge, et al. 2002) information, such as tax return information, lends itself to a host of different management systems. These might include, management information systems, decisions support systems, information storage and retrieval systems, auditing systems, collection and payment systems. Although, this is not intended to be a complete list it is enough to discuss existing and potential market opportunities for tax return preparation via e-commerce.

E-commerce opportunities

Perhaps no business process related to tax preparation lends itself to e-commerce opportunities like data collection. This is represented in our first step of the value chain model above. Aside from leading the way towards paperless systems, it is a vital aspect of tax preparation services. One company, Thompson Creative Solutions, www.creativesolutions.thomson.com/portals/ readily markets web sites to accountants with a client server feature. Via the accountants web site clients can log onto their secure site, and download and upload information. Looking down the evolutionary chain we can see how this e-commerce application can be enhanced to provide for an interactive, tax organizer interview, to gather client information for tax preparation. In other words, the formation of a client oriented extranet. In a recent article that discusses off the shelf tax preparation software (Carey, Yakal 2006, p.45), targeted to self preparers, TurboTax® and TaxCut®, already have interview features. This interactive feature may someday be adapted for a tax organizer, tax data collection system utilized by tax preparers to service clients. Another company Armen Computing at http://www.armencomp.com/ has developed software that is aimed at the retrieval of stock and other security trade transactions (Carey, Yakal 2006 p.46). The software will extract server information, from third parties, and populate Schedule D, in order to calculate gains and losses from securities transactions. As noted in their article, (Carey, Yakal 2006 p.45) many companies today are readily creating extranets that will make information available to their clients. The Internal Revenue Service (Berger 2005) is making attempts to expand its services to authorized third party preparers to promote e-filing. As revealed in a recent report, (Federation of Tax Administrators 2005) this development is usually a direct result of significant cost savings in labor, improved processing, and other increased efficiencies in delivering services to their clients.

E-commerce creates an opportunity for significant savings by providing access to markets, often on the other side of the globe, where the hourly cost of professional tax research and analysis services are a fraction of the rates typically charged domestically (Maher, 2004). A report by The Wall Street Journal, (Maher 2004) describes Mindcrest, Inc. with offices in Chicago. Located on the web http://www.mindcrest.com/ , Mindcrest offers a variety of services typically performed by law firms. Included in their services is research work with a staff of 15 located in Mumbai, India. The global reach of information technology and the application of e-commerce, creates 24 hour operations (Soled 2005), where foreigners, can perform “commodity legal work” (Maher 2004) anywhere in the world. This e-commerce model is likely to include competing alternatives to maintaining a fully staffed tax research department and all the associated functional costs.

Many software applications for tax preparation have been developed for the following business processes. (1) input of information into correct form(s), (2) tax return(s) preparation and assembly. These items are reflected in the proposed value chain as items 3, and 4 above. However, more recently there has been widespread use of business process outsourcing in these two areas. Cheaper labor costs together with advances in information sharing technology are enabling many tax preparers to outsource clerical, input and low level processing of tax return data. The type of work which usually creates seasonal employment opportunities for preparers. Business processes that tend to be more human intensive, (Ge, et al. 2004, p. 2) in nature and require a lower amount professional decision making, have seen a great deal of outsourcing opportunities in the e-commerce market. In their publication, Global Sourcing and Value Chain Unbundling (Ge, et al. 2004) the authors cite four “classification of sourcing mechanisms: domestic insourcing, offshore insourcing, domestic outsourcing, offshore outsourcing” (p. 6). However, a hybrid approach is also possible (Ge, et al. 2004). In their publication (Ge, et al. 2004) “governance”, or who owns and manages the business processes, are described as follows: Insourcing involves the use of a separate entity owned by a firm for the purpose of delivering a product or service. Outsourcing is the use of an unrelated third party firm in delivering a product or service (pp. 7-8). In practice today hybrid combinations are more often utilized for a variety of reasons. Outsourcing provides a means to re-channel, (Greenstein, Vasarhelyi 2002) certain aspects of the value chain.

As late as 2002, the Internal Revenue Service , had taken a position that it would not offer e-file services as it was not in a position to compete with commercial entities that provide those services (Hogan 2002). Today, not only does the Internal Revenue Service offer competitive e-file services, for free, it is also embracing new directives in utilizing e-commerce to provide new levels of services to taxpayers and tax professionals through disintermediation, re-channeling and to some extent cannibalization of existing operations. (Greenstein, Vasarhelyi 2002 chap. 2 ). For example, by means of re-channeling and perhaps a bit of cannibalization, (Greenstein, Vasarhelyi 2002 chap. 2) taxpayers enjoy the benefits of cooperative agreements between the Internal Revenue Service and other tax collection mediums on the internet. Accounting Web, Inc. (2005) reported two web sites: http://www.pay1040.com/ offers the ability for taxpayers to pay tax liabilities via credit card online. Another company Link2Gov located at http://www.officialpayments.com/ offers, an online tax payment portal that allows federal, state and local income tax payment capabilities in various forms, and also performs collection services for a host of different taxes and government collection agencies. In addition, the Internal Revenue Service offers its own Electronic Federal Tax Payment System through, http://www.eftps.com/ as yet another means to pay taxes. In just a few short years, many tax collection agencies are not only competing with the private sector in e-file capabilities but also assisting and welcoming new competitors and offering new mediums to their file and pay functions.

In a recent survey (Anderson, Fox & Schwartz 2005), for tax year 2004 61.5 million 1040 returns where filed electronically. That’s almost 47% of all 1040’s. In addition there is growing momentum by the Internal Revenue Service to make e-filing even more prevalent. Following the Restructuring and Reform act of 1998 (RRA 98), the Internal Revenue Service has had as its goal, 80% of tax returns be filed electronically by 2007 (IRS Oversight Board: Annual Report to Congress 2005). Although, the IRS has fallen short of that goal, advances in information technology together with a growing acceptance trend, would indicate high levels of participation in years to come (IRS Oversight Board: Annual Report to Congress 2005). However, in order to accomplish this the IRS Oversight board is asking for an extension date until 2011 (IRS Oversight Board: Annual Report to Congress 2005). It would stand to say that public private alliances, by re-channeling, deconstruction or unbundling (Ge, et al. 2004) of the tax preparation value chain, will continue to play a major role in achieving those deliverables established by RRA 98.

Implications of e-commerce in relation to tax preparation

Although e-commerce has many benefits for taxpayers as well as for initiatives in efficiency and effectiveness within government there are many different issues that will require resourcefulness if not a delicate balance to over come. Some of these issues are as follows:

Privacy Issues

Two important considerations in furthering e-commerce applications in tax preparation are: (1) Internal control systems in use by firms who process private and confidential taxpayer data and (2) the legal system that prevails when violations in privacy occur. India, a country who has extensive investments in outsourcing business processes, has no extensive legal framework to enforce electronic privacy rights (Dresner 2005). In Dresner’s article (2005), India is caught in a political debate between enacting law to enforce electronic data privacy or allowing companies to make contractual agreements as to how to protect privacy rights under existing laws already afforded under the law. Those who prefer a contractual solution claim it is less costly than compliance costs associated with legislation. In either case, internal control systems will be the key to complying with privacy rights.

Dilution of the Voluntary Tax System

With the proliferation of digitized taxpayer data, some private citizens and organizations are concerned about fueling big government (Lassman, 2002). Some view e-government as a threat. A fundamental aspect of the federal tax system in the U.S. is voluntary tax compliance (Lassman, 2002). Essentially, this allows taxpayers to use existing tax laws in making their own assessment of their tax liability. In an article published by a public policy think tank (Long, 2002), the author explains the expansion of the Internal Revenue Service through e-commerce applications, means they are in a position to be “tax collector, preparer, auditor and adverse litigant to the taxpayer”. Reading articles such as in Long, (2002) and Lassman (2002) we can envision the possibility of extensive databases of digitized taxpayer information, used improperly, could give government the ability to profile taxpayers. Alternatively, because a given tax transaction may have more than one tax treatment, a justified tax position and a subsequent audit, brought by profiling, could preclude a legal tax position due to the costs of an audit.

Information Security

Digitized taxpayer information residing in databases have by their very nature the inherent risk that the databases may become compromised by a variety of threats. These threats include viruses, natural disasters, unauthorized access just to name a few. A breach in system security could mean vast numbers of taxpayer records could be compromised in seconds. The April 2005 report by the GAO (United States Government Accountability Office 2005), to the House of Representatives, on Internal Revenue Service information security, outlined 21 security risks not addressed by the Internal Revenue Service from a prior 2002 GAO report. In addition, 39 newly created security control weaknesses were cited in the same report. The weaknesses noted in the report range from impairment of the Internal Revenue Service to maintain confidentiality, integrity and availability of sensitive financial and taxpayer data. Also noted were deficiencies in training, impairment to control authorized access and physical system security concerns.

In light of today’s war on terrorism, breaches of sensitive taxpayer information could create many challenges for outsourcing to certain countries or even to outsourcing as a whole.

Professional Standards and Concerns

Advances in technology are requiring accountants to rethink risks, exposure and adherence to professional standards. According to an article in the Journal of Accountancy, (Shamis, Green, Sorenson & Kyle 2005) The American Institute of Certified Public Accountants requires under the rules of ethics, that all CPA’s who disclose confidential client information to an outsource provider or an independent contractor, disclose this information to the client preferably in writing. In addition the article points out the number one professional concern to outsourcing is maintaining client information security. In the article, (Shamis et al. 2005) focus groups of clients felt uneasy about their personal financial information being displayed across the globe. Furthermore, there is some doubt as to coverage under liability insurance, for third party vendor employees if they are not accountants.

In an article published by The CPA Journal, (Soled 2005) depending on the extent of involvement by a third party outsource vendor, would the Internal Revenue Service consider an outsourced third party to be a paid tax preparer? The article points out, according to the Internal Revenue Service, certain third parties who prepare tax returns in return for compensation and who engage in acts beyond typing, reproducing or other mechanical systems are liable and subject to liabilities and civil actions under the code.

Other legislation beyond those imposed by the Internal Revenue Service are also affecting how tax preparers practice. According to The CPA Journal (Soled 2005) the Gramm-Leach-Bliley Act of 1999 requires certain privacy disclosures to be made including, the firms information collection and sharing practices. The 1999 Act also requires to give clients an opt-out right.

All indications would lead accounting professionals to develop their own e-commerce strategies for tax preparation as well as for other services rendered. However, acceptance of outsourcing and other e-commerce applications will require evaluation of professional, regulatory and other social political implications before moving forward. Due to significant operational efficiencies and cost savings of e-commerce , e-government is likely to see further development. However, there will likely be privacy and big government issues that will have to be addressed, in order to continue these efforts and protect taxpayer rights and privacy concerns.



References

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