Electronic Income-Tax Filing

views updated

ELECTRONIC INCOME-TAX FILING

Electronic filing of taxes enables professional tax preparers and most taxpayers to submit tax returns to the Internal Revenue Service (IRS) and some state agencies via computer modem. Taxpayers have various options for filing their taxes electronically. They can use special tax software to prepare their returns, and then transmit the completed forms electronically to an authorized intermediary who will forward them to the IRS. They also can take a completed paper form to an authorized intermediary for transmission, or have an authorized preparer complete their taxes and transmit them. As of 2001, taxpayers could not transmit their completed tax forms to the IRS directly via the Internet. A limited number of taxpayers also can file returns using a touchtone phone. In 2001, only taxpayers who were expecting a refund could e-file. However, that year the IRS announced that, under a pilot program in nine selected states, e-returns would be accepted from taxpayers who owed the government taxes.

In addition to filing electronically with the federal government, taxpayers can file state taxeselectronically in some states. Using an IRS program called Federal/State E-File, taxpayers transmit their state and federal returns together to the IRS. The agency then forwards the state return to the appropriate state's tax board. The service initially was available in 37 states and the District of Columbia.

The number of tax returns filed annually has paralleled the rise of the World Wide Web. In 1986 the IRS reported about 25,000 electronic tax returns. In 2001 more than 40 million federal income tax returns, of a total 130 million, were filed electronically. However, the IRS must find ways to inspire ever more taxpayers to e-file—a 1998 act of Congress required that 80 percent of all returns be made electronically by 2007.

HISTORY

By the time the IRS introduced electronic filing during the 1986 tax year, more and more taxpayers had begun preparing their returns on personal computers. The agency's main idea was to cut its own costs of processing returns. Every year thousands of temporary employees had to be hired to sift through mountains of tax returns, and then check and enter the data by hand into IRS computers. E-filing eliminated much of that human labor. In 2001, according to the agency, processing an e-return cost only 74 cents, compared to about $1.50 for a traditional paper return.

E-filing was tested in three cities in 1986 and proved so successful it was expanded to four more cities the following year. In 1988 the program included 14 states. From the beginning, e-filers did not submit returns directly to the IRS. They were transmitted to an IRS-authorized private agent, usually an established tax firm, which transmitted them to a regional IRS office. Intermediaries usually charged a fee, anywhere from $25 to $75, for e-filing returns. One attraction of the service for taxpayers was the promise of a refund check in as few as two weeks. To sweeten the deal, the tax firms sometimes offered, for another fee, "refund anticipation loans"—a check for the expected refund issued as soon as the return was sent to Washington. Following the e-submission of a return, taxpayers affixed their signature to a paper form and mailed it to the IRS separately.

The rationale for using intermediaries to e-file at the time was partly that the modems and other necessities for e-transmission were still expensive and uncommon in most homes. Ironically, for the first few years the IRS did not have the technical capability to transmit returns electronically from regional offices to its headquarters in Washington. They had to be copied to magnetic tapes, which were then mailed to IRS headquarters.

In 1988 the lure of quick refunds drew 583,462 e-returns. In mid-March 1990, with still nearly a month to go until the filing deadline, the IRS had received 3.5 million returns. In 1992, 11 million e-returns were made. In 1993, the IRS approved commercial software for the 1040PC—a tax form that could be filled out on a PC, printed, and then mailed to the IRS. Even those helped trim IRS costs because of the higher accuracy compared to older methods.

Despite demands from some congressional members that taxpayers be allowed to transmit their tax forms directly to the agency rather than forcing them to pay an intermediary to do it, the original system has survived. However, by the end of the 1990s tax returns could be submitted to authorized businesses for further transmission using a software package approved by the IRS. In 1998, 500,000 individuals filed from home. The following year, that number mushroomed to 2.5 million. In 2001 the paper signature form was eliminated for those electronic filers and replaced by a five-digit number that the IRS issued to each e-filer. Together with specific information from the previous year's tax return, that number was used to identify each taxpayer.

ADVANTAGES AND DISADVANTAGES

E-filing provides many advantages to taxpayers. Quick processing means refunds are received much sooner, particularly if they are deposited directly into a bank account. Errors are reduced at both ends and e-tax preparation software can sometimes suggest deductions, review returns for data that could lead to an audit, or even download W-2 and 1099 forms. Federal and state returns can sometimes be calculated together. However, e-filing has disadvantages as well. About one-fifth of e-filers had their e-signatures rejected for some reason in 2001. Between the cost of software and finding an authorized agent, e-filing can cost more than mailing a traditional paper return. About 40 forms were not available in e-versions as of 2001, according to the IRS, and some 10 percent of taxpayers were still not eligible to file electronically.

However, perhaps the most serious downside of e-filing for most taxpayers was the question of the security of their personal and tax data. These concerns were exacerbated by a 2001 General Accounting Office report that uncovered lax security in the IRS's computer systems. Although no evidence of hacking into the system was uncovered, GAO investigators were able to gain unauthorized access to computers containing taxpayer files. Following the report, the IRS took steps to improve its computer security. Additional security concerns were raised by a proposed IRS plan to increase the number of e-filers. In return for distributing free tax software to consumers, the IRS considered sharing taxpayer information with private firms. The plan eventually was scrapped. However, despite such concerns, the continuing expansion of personal computers and Internet access will make the growth of electronic tax returns inevitable.