The IRS developed the Modernized e-File (MeF) system in the early 2000s and first deployed it in 2004. MeF is an Internet-based system that allows taxpayers to electronically file corporate, individual, partnership, exempt-organization, and excise tax returns. Working with the Federation of Tax Administrators and 28 state tax agencies, the IRS expanded MeF in 2006 to support federal-state electronic filing of business tax returns. Nearly every state now participates, and the benefits are obvious: electronic returns are processed faster and with fewer errors than paper returns. Sounds nearly perfect, right? Not quite.
I’ll avoid getting too technical, but a brief overview of the process is helpful. Federal and state returns must be submitted in an IRS-approved format, and a state return must conform to the IRS return structure while also including the data elements required by that state. After the IRS receives an electronic return, MeF acknowledges receipt and begins a validation process. A return that passes validation is accepted, and MeF generates another acknowledgement. A return that fails validation is rejected, and MeF generates a rejection notice identifying the error category, message, and other relevant data. The IRS transmits this information to the states, which conduct their own validation of state returns.
Because “stuff” happens and information systems do not always work perfectly, the IRS provides a “perfection period” for electronically filed returns. For example, Form 1120 returns have a ten-day perfection period. If a taxpayer timely submits a return that is rejected, the taxpayer may correct and retransmit it during that period while retaining the original filing date. But a state’s participation in MeF does not, by itself, mean that the state recognizes the federal ten-day perfection period. Most states follow the federal rule, but some provide a different period, and others provide no perfection period at all.
More than half of the states participating in MeF follow the federal perfection period. Roughly ten others provide different periods, ranging from 24 hours to seven days. At least seven provide no perfection period at all, and some of those states also require corporate taxpayers to file electronically. That combination matters because certain elections, deductions, and credits may depend on filing a timely return. A taxpayer that timely transmits a return that gets rejected for a technical but non-substantive reason could face an unexpected tax liability even if resolving the problem with a short period of time solely because the state provides no opportunity to perfect the filing. There is no good reason for that result.
Every state should adopt and clearly publish a perfection period for electronically filed returns, especially when electronic filing is mandatory. After all, nobody’s perfect.