IRS Modernization Efforts Pose Challenges as Enterprises Embrace eFiling

Digital transformation is becoming as inevitable as the reality of paying taxes. And as many companies discovered during the recent tax season, even the IRS is going digital.

As Wendy Walker, solution principal at Sovos, told PYMNTS, the Internal Revenue Service’s ongoing digitization efforts pose challenges — and benefits — for enterprises switching from paper-based filing and processes.

“Like any large business, the IRS has a vast portfolio of operating systems,” Walker said. The agency relies on more than 40 mainframe systems, over 900 mid-range systems and close to 3000 vendor-supplied applications.

Some of those legacy applications and systems, she observed, are decades old — stretching as far back as the 1960s. Some of them still operate with “green screen” terminals.

The antiquated operations mean that there’s still a significant amount of time and resources spent entering data manually, and there’s still a huge amount of paper in the mix.

As the National Taxpayer Advocate Erin Collins said to Congress in 2022, and as recounted by Walker: Paper is kryptonite to the IRS — and it’s buried in it.

In addition to millions of income tax returns and employment tax returns, the IRS receives over 5 billion information returns annually, in the form of 1099s and W-2s. While most of them are filed electronically, there are still tens of millions of information returns filed via paper submissions.

Striving Toward Modernization

Little wonder, then, that beginning in 2019, the “system modernization journey” — as Walker termed it — took root with the Taxpayer First Act (TFA). Congress mandated that the IRS would have to “reimagine” the taxpayer experience — with 45 provisions that restructured the IRS and charted a path toward improving all manner of taxpayer interactions, including updating systems and  processes.

To modernize the intake of 5 billion information returns, the TFA mandated that the IRS build a new 1099 reporting system and with help from annual appropriations.

Last year, the IRS debuted the Information Return Intake System (IRIS), an online 1099 filing system that allows filers to manually create and electronically file 1099 returns. However, the system is not yet ready to take in billions of information returns electronically. Businesses with hundreds to millions of returns to file need a more streamlined method.

With help from Inflation Reduction Act funding, the IRS has been working to build application programming interface (API) connectivity since last year. The benefits of modernizing this transfer of data include reduced errors and faster processing times.

“Being able to click a button within an application and have it send that information directly is going to take a lot [of inefficiencies] out of that filing process,” Walker said. In addition, the IRIS platform alerts filers in real time whether critical information is missing or invalid from the returns, including incorrect taxpayer identification numbers.

For corporations (especially the firms that make up Sovos’ client base), and for financial services firms in particular, the IRS’ efforts may have a ripple effect.

“With respect to the IRIS system,” she said, “it’s a huge shift for the industry.”

Enterprise accounting systems like SAP and Oracle and core payment and financial services platforms like Fiserv and FIS all have built-in programming for generating the current IRS 1099 file format. States require information return reporting, and most rely on the legacy FIRE (that’s “filing information returns electronically”) system, a network used for processing filing forms.

“Organizations need to think about how the IRS is moving all of us over to IRIS and away from the legacy systems,” including the already-in-place FIRE, said Walker, because IRIS requires different filing formats and processes.

She advised that companies should consider implementing a project team to help manage those operations and technology changes. The transition may be especially challenging if the IRS decides that it will not continue to support some of the information return types on FIRE, forcing a filer to file return information in both IRIS and FIRE to comply with annual filing requirements.

In the months ahead, she said, paperless initiatives will continue to be a top priority at the IRS, and there will likely be more legislation from Congress mandating more eFiling initiatives and technological  innovations.

“You have to think from an organizational perspective about how you’re going to change over those systems and processes and procedures, and what those impacts are to everybody in between … and be prepared to respond on your timeline as an organization and not hopefully on the IRS’,” she said.