What Is EDI?

EDI is a means of electronically exchanging information in a standard format from one computer to another. According to Accounting Information Systems (Cushing and Romney), over 15,000 companies use EDI for routine business transactions such as ordering and invoicing, and the number of participants is doubling annually. EDI allows companies to eliminate the paper and postage formerly associated with these routine transactions. EDI has been operational for about 20 years, but it became popular primarily in the last few years due to the rapid growth in PC and modem technologies. Although users having high volumes of transactions may still need a mainframe or minicomputer, EDI is now operational in PC and LAN environments.

Under EDI, documents are transferred from the sender's electronic mailbox to that of the recipient. Documents can be sent directly, or through a value-added network (VAN). Most EDI participants use VANs, which are third-parties offering fee-based services such as simple connections and protocol conversions. The VAN routes each transaction to the appropriate electronic mailbox where the message stays until the other party downloads.

A key to EDI is the standardization of formats for electronic data transfers. Each frequently used document, such as a purchase order, has a generalized format known as a "transaction set." Transaction sets are developed by a committee of the American National Standards Institute (ANSI); this committee, known as ASC X12, is comprised of individuals and organizations having an interest in the development of standards. Once a standardized format is developed and a transaction set created, it is available to EDI participants.

Applicability to Tax Return Filing

Tax return filings are routine transactions not unlike purchase orders and invoices. Thus, transaction sets have been developed for tax filing. Transaction Set 813, Electronic Filing of Tax Return Data, can accommodate the filing of any tax to any taxing authority, whether state, local, or federal. Transaction Set 151, Electronic Filing of Tax Return Data Acknowledgement, allows the tax authority to acknowledge, acknowledge with changes, or reject the EDI return. Exhibit 1 illustrates the filing process.

The tax authority, the tax return preparer, and the taxpayer will benefit from EDI tax filing. The IRS or other tax authority will achieve faster, more accurate tax return processing due to the elimination of the manual data-entry process. Processing costs are reduced as a result of the elimination of workers needed to enter data from paper realms. Similarly, tax return accuracy is enhanced due to the elimination of human error. Additional savings are obtained through a reduction in the quantity of paper tax forms that the tax authority must print annually. Finally, the tax authority obtains cost savings due to the decreased amount of storage space resulting from the reduction in paper.

The tax return preparer will benefit from EDI filing in several ways. First, because the tax authority will acknowledge or reject the electronic return, any data errors or omission errors will be flagged, enabling the return to be corrected and resubmitted, Secondly, EDI filing should simplify state and local tax filing since the same transaction set format is used for any state and local tax. Finally, the amount of paper will be greatly reduced, resulting in cost savings due to reductions in clerical help and storage needs.

Benefits to the taxpayer include faster refunds resulting from the speedier tax return processing by the tax authority. Also, the acknowledgement of the return having been received by the tax authority may be important to the taxpayer in certain situations.

EXHIBIT2

SUMMARYOFSELECTEDFEATURESOFEDIANDEFS

EFSEDI

Acceleratedrefundcomparedtotraditional

paperreturnyesyes

MathandaccuracychecksbyIRSuponreceipt

oftaxreturnyesyes

AcknowledgementsentbytheIRSuponacceptance

oftaxreturnyesyes

Specializedsoftwareneededyesyes

Expansionplannedforcorporateandothertypes

oftaxreturnsyesyes

ApplicabletoallFederal,state,andlocalreturnsnoyes

Hardware, Software Needs

To participate in EDI filing, the CPA needs a personal computer, a standard modem, standard communications software for use with the modem, and EDI translation software. EDI translation software may be integrated into a tax preparation software package or it may be purchased as an additional program for use with the tax preparation software. The software translates the tax return into the standard transaction set format. Once the IRS makes the software specifications available to the software companies, they will be able to integrate the existing tax software with EDI.

In addition to the cost of the translation software, the CPA or other return preparer will incur the costs associated with learning a whole new way of processing information. CPAs who have not yet adopted the current electronic filing system (EFS) will find that procrastination paid a dividend, since they will avoid having to go through the learning process twice.

The tax return preparer's cost of adopting EDI filing should be comparable to the cost associated with EFS. An advantage of EDI over EFS is that, in the past, EFS usage required the tax return transmitter to purchase a bisynchronous modem costing about $2,000, which is different than the standard asynchronous modem that is purchased with most PCs (the IRS is planning to allow standard asynchronous modem usage for EFS during the 1995 tax season). Another advantage of EDI is that the same transaction set is used for all Federal, state, and local tax returns. After seven years of operation, EFS is capable of joint Federal-state filing in only 30 states, and it is not operational for local tax filing. Finally, as many EFS return preparers utilize the service of a third-party transmitter for the actual sending of electronic returns to the IRS, most EDI fliers will also utilize the service of a third-party VAN. Exhibit 2 summarizes some of the features of EDI and EFS.

Implementation

The IRS is pilot testing EDI in October 1994 with four fliers of Form 941. By April 1995, the IRS expects Form 941 filing to be expanded to all taxpayers serviced by the Memphis Service Center, plus other selected areas, Forms 1040A and 1040EZ are scheduled for January 1995, and all other 1040-series returns are scheduled for January 1996. Filers of corporate returns will be able to file EDI returns in January 1997, and the timetable for partnership returns is January 1998. Once EDI is fully operational, the IRS plans to support dual EFS and EDI systems until it determines that support for both is not cost beneficial (IRS Pub. 1811).

Alan Levitan, PhD, CPA, S. Srinivasan, PhD, and Richard M. Walter, PhD, CPA, are associated with the University of Louisville.