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The Trouble with e-filing your taxes

Filing your tax return electronically is quick and saves the IRS tons of money. But it doesn't save you money, may not save you time, and may expose you to extra IRS scrutiny.

By Jeff Schnepper

The Internal Revenue Service really wants you to file your tax returns electronically. The agency's goal is to have 80% of all returns filed electronically by 2007.

And, so far, the results are impressive: Fully a third of tax returns are filed online, and to get you to file electronically, they make two big promises.

The biggest is: If you file early expecting a refund and use direct deposit, you'll get your money back much more quickly than if you file by mail.

Second is that the return will be more accurate. IRS staffers who process returns by hand do create a number of errors.

Another reason the IRS likes e-filing is that it reduces risks to its employees. Last year, two postal employees died from complications from handling mail that was contaminated by anthrax. The IRS has moved the processing of mailed returns away from its main facilities, but that produces more delays for taxpayers.

But, lately, I've begun to have some problems with e-filing. Here are the problems I see.

E-filers are starting to encounter delays
John G. Ams, executive vice president of the National Society of Accountants (NSA), a trade organization of some 30,000 accountants, has charged that some "delays in refunds on electronically filed returns…stretch far beyond" the dates indicated by the IRS.

NSA Tax Manager Bernie Phillips reported receiving complaints from at least 80 accountants around the country about refunds on e-filed returns that were delayed four to five weeks -- some even longer. In one case, a taxpayer filed for an $11,600 refund on Jan. 28. The IRS initially paid the refund by direct deposit, then took the funds back, and it took six weeks to finally pay the refund. Statistics from past filing seasons showed such refunds being paid within 10 days. The IRS says it attempts to get refunds from returns that are electronically filed deposited into bank accounts within two weeks.

An IRS spokesman has said it does not guarantee to pay a refund by a specific date. It recommends that taxpayers wait at least three weeks before even checking on the status of a refund, no matter how it's filed.

The IRS has issued a schedule indicating that direct deposit of tax refunds from e-filed returns would be made within one to two weeks, and that paper refund checks would be mailed within another week. But this schedule is only a target, not a "guarantee."

E-filers are being investigated
Most disturbing to me was Ams' revelation that some refunds exceeding $10,000 are being reviewed by Criminal Investigation, the investigative arm of the IRS. "When we couldn't figure out why refunds were being delayed," Ams said, "we were told the returns were being looked at." And, he added, his members were told returns filed through the mail were not subject to the same scrutiny.

You file in a way that helps the IRS. The size of the refund triggers a prompt for someone to look at the file. That means the IRS keeps more than $10,000 of your money, doesn't pay you a penny of interest, and you are potentially the criminal?

Why is the IRS targeting such e-filed returns? Theoretically, the only difference between e-filed and mailed returns is the speed of processing. It could well be that the IRS, under pressure to root out tax cheating, is looking more closely at those returns that claim large refunds. Electronic returns are supposed to allow a quick deposit of dollars into your account. But the IRS seems concerned they may also provide a fairly easy way to defraud the government. By the time the IRS finds the fraud (false credits/deductions etc.), you're long gone. E-filing and direct deposit sure beats snail mail if you want to "hit and run."

E-filing favors the IRS but not you -- especially if you owe
E-filing is a great deal for the IRS. It saves millions in man-hours and crushes the cost of processing and storing paper returns.

The 2002 federal tax-filing season set records for the number of returns processed and filed electronically. About 43.6% of all 2002 returns were filed electronically through April 2003. That meant that more than 47 million taxpayers had e-filed. And taxpayers filed more than 9.1 million returns from their home computers, up 34% from 2001. And lastly, nearly 36.5 million taxpayers used direct deposit for their refunds. Only 34 million used it in all of 2001.
E filing is so attractive for the IRS that it has suggested two proposals to boost numbers next year and beyond.

An extra 15 days -- until April 30 -- to e-file and pay. THANKS…for nothing. Supposedly, the biggest attraction for e-filing is its speed. I'm in no rush to pay. If I owe, I'd rather file on April 15, with proof of filing, and hope that between the efficiency of the Postal Service and the competence of the IRS, my envelope gets opened in about three years. If I had a refund coming, I'd have e-filed in February!
Free e-filing. It now costs around 60 cents to mail a 2-ounce paper return. On average, e-filing costs about $13 -- a fee paid to the tax preparer, not to the IRS. All of this "free e-filing" is going to be a shot in the arm for those companies that market tax preparation software. And while it may be free e-filing from the point of view of the IRS, tax preparers will probably still charge you to send in the return. On June 6, Terry Lutes, director of the IRS's Electronic Tax Administration, announced that the IRS is close to an agreement with the tax preparer industry -- lobbyists from the tax software firms, big accounting firms, and the American Institute of Certified Public Accountants -- to provide free electronic filing of tax returns.

He said that the "EZ Tax Filing" proposal should be available for the 2003 filing season, but there are still "three or four issues still to be resolved." A key issue for me is to find a way for the government to offer a product that does not compete with the private sector. The IRS expects to have a proposal available for public comment sometime this summer.

On the other hand, if the IRS and Congress really want 80% of the returns to be e-filed, the best way might be for the IRS to develop its own software and give it away. Or, how about this: The IRS could provide free direct filing on its Web site. This assumes that anyone -- even those taxpayers with complicated returns -- could use the software and get accurate results.

In that case, the tax software vendors should prepare to go out of business. Why would a tax preparer buy what is currently expensive tax software to prepare and file returns if he can just file straight to the IRS?

The bottom line for me on e-filing is this: No matter how many temptations the IRS puts on my table to induce me to e-file, I'm not going to do it if I even imagine a refund is going to put my return in the "criminal" file. I'm all for e-filing, but you should know the risks, even those you might not have considered.

Maybe that's why 17 years after e-filing was introduced, nearly two-thirds of this year's 130 million tax returns were mailed.

Jeff Schnepper is the author of several books on finance and taxation including "How Much is it Worth? Asset and Business Valuation," "The New Bankruptcy Law: A Professional Handbook," and "Inside the IRS, How it Works (You Over)." A former professor of taxation, accounting and finance, Schnepper has argued before the U.S. Supreme Court and has appeared on numerous national and local television programs. He lives in New Jersey.

Jeff Schnepper

...in this world nothing is certain but death and taxes. — Benjamin Franklin