Popularity of E-filing Hits a High Point

(Chicago Tribune) -- For the first time ever, the majority of individual federal income tax returns were filed electronically this year, a milestone reflecting the ongoing boom in tax software.

As the digital revolution meets the tax code, the Internal Revenue Service, software companies and independent researchers are only beginning to understand the consequences.

In many respects, all that computing power has made the annual tax ritual much more speedy and efficient. E-filing eliminates the need for IRS workers to laboriously keypunch paper returns into agency systems, and computer programs sharply reduce simple math errors and data omissions.

Eager to boost its productivity, the IRS has made computerized tax preparation a top priority, offering more than a dozen free programs on its web site IRS.gov. Yet putting enormous computing power at the fingers of taxpayers and their paid professionals is influencing behavior in unintended ways, experts say. Even rudimentary programs enable users to track the effect of each entry on refund size, for instance. Many issue a warning when an outsized deduction or credit might trigger an audit.

Academics have found intriguing evidence about how taxpayers react as the refund meter creeps toward tax due, or the charitable donations move into red flag territory.

At TurboTax parent Intuit Inc., it's understood that customers who "have an idea of how much money they should get back" tend to work over the numbers to achieve the desired results, said spokeswoman Julie Miller. "They keep an eye on that refund monitor and adjust accordingly."

Beyond that, since computers handle complex formulas and generate forms automatically, some believe they indirectly encourage ever-greater complexity in the tax code.

Without computers, the frequent revisions by Congress over the past 20 years would have triggered a revolt, said Charles Rossotti, former IRS commissioner and author of "Many Unhappy Returns," a new book on modernizing the agency. "If you didn't have computers, no one could have coped with that."

Even more disturbing to some, the rise of foolproof tax programs has reduced the need for Americans to follow the process.

"People understand less of why they're paying what they're paying," said Eric Toder, a senior fellow at the Urban Institute think tank and former director of the IRS research office.

As Itasca, Ill., tax attorney and accountant Richard Colombik puts it: "Most people are filling in blanks. It's just like schoolchildren learning to do math on a calculator. Because of the technology, people don't utilize their brains as much."

For the many Americans who want as little to do with their taxes as possible, that's hardly a problem. 
Just ask Janet Torelli, a Chicago hairdresser who happily hands over her personal and business taxes to a computer-equipped accountant and leaves it at that.

"They do everything, and I like it that way," said Torelli, sole proprietor of the Spitcurl salon. "There are very few things in life you can delegate successfully. I just get the stuff back that I sign and send to the government."

Computers began playing a role in individual tax filing during the 1980s. TurboTax, by far the leading program, is in its 21st year. H&R Block, which markets the No. 2 TaxCut software and has the biggest network of tax preparers, started laying the groundwork for e-filing two decades ago.

In the 1990s, the market boomed, and some 15 percent of all returns were completed by do-it-yourselfers using TurboTax last year.

This tax season, shipments of TurboTax have shot up 11 percent to 9.13 million units as of April 2, and free downloads through the IRS web site have nearly tripled to 1.75 million.

The Mountain View, Calif.-based company is targeting younger filers with a simplified version of its program, believing it can convert them over time to more sophisticated products as their returns grow in complexity.

Intuit's main goal is winning over taxpayers to do-it-yourself software programs from other methods, Chief Executive Steve Bennett told Wall Street analysts earlier this year. "Our competition is H&R Block's franchise operations. It's going to a pro. It's pencil and paper."

So far, pencil and paper is the big loser. Even as do-it-yourself software has caught on, professional tax preparers have expanded their market share as well.

Almost 56 percent of the nation's 134 million individual returns were professionally prepared as of 2003, up from 46 percent in 1986, according to the IRS.

Chalk it up to the ever-more-confusing tax code, said Cindy Hockenberry at the National Association of Tax Professionals. "More people are seeing more preparers," she said. "It's attributable to how complex things have gotten."

Naturally, every taxpayer wants to know which method works best. Conventional wisdom holds that software is cheaper and more efficient, especially for simple returns, while professional advice easily can pay for itself when the going gets tough - and certainly for longer-range planning and strategizing.

Still, conventional wisdom has proven difficult to verify. Side-by-side comparisons using identical returns have become a media staple and, not surprisingly, they sometimes result in different bottom-line tax calculations. TurboTax might provide a bigger refund in one test, a professional adviser in the next. Much depends on what's asked and how the questions are answered.

H&R Block spokesman Tom Linafelt said he has learned to go last in such comparisons, since the answers to key questions tend to get fine-tuned as competing methods are used on the same return.
A similar idea underlies Block's "Double-Check Challenge," the tax service's widely advertised offer to review any taxpayer's past returns for missed deductions and the like. Block can often improve on the previous results, Linafelt said.

Given the stepped-up competition, improved technology and the emphasis on uncovering legitimate ways to reduce the tax bite, it might seem the rise of computers inevitably cuts into tax revenues. To some extent, however, it cuts both ways.

A recent study co-authored by Texas Tech University Prof. Robert Ricketts revealed that do-it-yourself tax programs sometimes throw a scare into less-confident users.

Ricketts and his colleagues focused on the programs' so-called "audit flags," which identify specific items likely to spark IRS scrutiny. Confronted with those electronic cues, some taxpayers reduced their claims for otherwise allowable deductions. In addition, the programs created enough uncertainty that taxpayers became more conservative in their measurement of income or losses.

As a result, typical users reported significantly more taxable income when confronted with the audit flags than when they did not.

On the other hand, Ricketts said, similar research suggests the flexibility of the programs makes it much easier for aggressive taxpayers to "game" the numbers.

Program features showing that average taxpayers take substantial deductions for noncash charitable deductions, for instance, may well encourage an illegitimate entry, he noted.

In particular, software users behave differently if they think they are going to owe money, he said. "They tend to be a lot more aggressive in reducing that check they're going to have to write" - much more so than in maximizing a refund, he said.

On balance, not much of the nation's projected $300 billion tax shortfall is attributable to such manipulations, however. The bigger problem by far is hidden income, and computerization has no bearing on whether a taxpayer chooses to omit key numbers, said Rossotti, the former IRS commissioner.

"If someone's going to cheat, they're going to cheat," he said. "Computers help to reduce errors and ease the process for the taxpayer. It really has improved the process."