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IRS forces paper out of taxpayers' hands

Agency offering carrots and sticks to force taxpayers and preparers to file electronically. Plus, tax benefits to remember this year.

By MSN Money Partner Mar 21, 2011 6:39PM

Wall Street Journal on MSN Money
This article is by Laura Saunders of The Wall Street Journal.


Tax season is in full swing. But something is missing: the forms the Internal Revenue Service sends out in the mail every year.


It isn't a mistake. As part of a push to have more taxpayers file electronically, this year the IRS ended its decades-long practice of mailing paper packages to taxpayers.


In 2009 it cost the IRS only 19 cents to process an e-filed return, compared with $3.29 for one on paper.


There are other important tax-code changes to be aware of as well, many of them a result of December's sweeping tax legislation. They affect health insurance for the self-employed, charitable IRA rollovers, sales taxes and other items.


Yet the "e-filing" push will be the biggest and most jarring change for many. Although e-filing has caught on over the past decade -- nearly 70% of 142 million individual returns were e-filed last year, up from 23% a decade ago -- it has been least popular among wealthier taxpayers. To promote e-filing, the IRS this year stopped mailing forms to people's homes automatically and mandated that preparers of more than 100 returns e-file them. Next year, that figure drops to 11.


The upshot: "This is the first time many higher-income taxpayers with complex returns will have to decide whether to e-file," says Benson Goldstein, an official with the American Institute of Certified Public Accountants.


The IRS' effort includes new rules some see as heavy-handed. This year preparers who are required to e-file are prohibited from taking clients' paper returns to the post office, as many have long done. And clients have to sign a waiver saying no one dissuaded them from filing electronically. "This is a real pain and nobody likes it," says Janet Hagy, a CPA with her own firm in Austin, Texas, "but I don't want to get fined."


Taxpayers still may opt to file paper returns, of course. But there are early signs the IRS' campaign, which was ordered by Congress, is working. Lawrence Best, a New York CPA who figures he has prepared more than 30,000 returns in his 31 years of practice, says he was an "old dog who didn't want to learn new tricks" until forced to e-file this year. Now, he says, "I recommend it, and clients do it."


While e-filing may be good for the IRS, taxpayers should make their own decisions. There are important reasons why some people should stick with paper. Here is what you need to know, plus more on this season's other important changes:


The benefits of e-filing


For most taxpayers, the biggest advantage of e-filing is that it is easy and can be free. "I e-filed my own return free through the IRS website without a hitch," says Melissa Labant, a tax expert with the American Institute of CPAs, who is relieved she didn't have to go to the post office.


E-filing also is less prone to human error, both by the IRS and taxpayers. Electronic returns don't have to be entered into the system by hand, and the IRS' computers reject any returns with incorrect basic information such as Social Security numbers, birthdates (even of a child) and married names (they must match what is in Social Security records). This hair-trigger sensitivity is frustrating in the short run but prevents problems later.


Another benefit is that the IRS notifies the taxpayer or preparer, usually within 24 hours, that it has accepted an e-filed return. Otherwise it could take months or years before a missing return is noticed. At the same time, e-filers who owe Uncle Sam don't have to pay up when they file. A payment may be withdrawn directly from your bank account later, or the taxpayer may mail a check to the IRS.


E-filed returns bring quicker refunds, too, and they can be made directly to a bank account. Some taxpayers might prefer an old-fashioned check, but at times a direct deposit helps with security issues.


Andrew Mattson of Mohler, Nixon CPAs in Campbell, Calif., had a U.S. client in Singapore who was owed more than $200,000 by the IRS. The paper return requested direct deposit of the refund to a U.S. bank, but the IRS overlooked it and mailed a check to Singapore. Although the check arrived, there were fears it wouldn't. "This request would not have been missed with e-filing," Mr. Mattson says.


The trouble with e-filing


Some taxpayers can't e-file, and preparers say others shouldn't. Those taking adoption credits or first-time home-buyer credits have to file on paper. Other forms that may have to be filed on paper include form 8283 for noncash charitable contributions. Several experts, including Atlanta-area CPA Robert Gard of Gard & LaFreniere, recommend filing the entire return on paper if one part has to be paper.


Hagy advises paper filing whenever a taxpayer needs to attach documents such as a power of attorney. She says it also can help "control the exact information submitted for unusual disclosures," such as a disputed distribution from a partnership or foreign transactions reported by hedge funds.


Mass computer glitches happen, and those who fear them may want to think twice before e-filing. In January, the state of Georgia issued refunds totaling more than $12 million directly to the accounts of more than 32,000 taxpayers. Shortly after it yanked the refunds without giving notice, leaving some taxpayers overdrawn, and has had to pay nearly $21,000 in reimbursements for taxpayer costs.


The IRS also had a malfunction this year in which up to 200,000 e-filing taxpayers who planned direct withdrawals of tax payments from their accounts on April 18 were sent notices for payments due. A spokesman says the agency has corrected the error.


Computer security is another issue. Several experts said they were comfortable sending online returns to the IRS. But Joseph Quickle, an executive with 41st Parameter, a Scottsdale, Ariz.-based online-fraud-detection firm, says he will use only an installed application to figure his tax, as opposed to doing everything online.


"Browser-based communication is more subject to eavesdropping," he says, "and my return has way more information than I want in anyone else's hands or database, including the vendor's."


Finally, the Big Question: Does e-filing raise the chances of an audit? There isn't any hard evidence either way. Some e-filing fans, like Doug Stives, a CPA from Red Bank, N.J., think it keeps taxpayers "below the radar." But a 2009 report from Congress's Joint Tax committee linked e-filing to a higher overall audit rate, saying the cost savings made the IRS "better able to make use of its computer infrastructure to target returns with audit potential."


Health insurance deduction


Once you figure out whether to e-file, you can avail yourself of some new or renewed tax breaks. Among them: for 2010 only, self-employed workers who can deduct health-insurance premiums also may write them off against Social Security taxes on Schedule SE.


For 2010 and after, self-employed workers who deduct insurance premiums also can include premiums for all children under age 27 at the end of the year, even if the child isn't a dependent for tax purposes.


Charitable IRA rollovers


Late last year, Congress extended for 2010 and 2011 a popular provision allowing taxpayers over 70½ to contribute as much as $100,000 of IRA assets directly to a charity. This donation isn't tax deductible, but neither does it raise reported income in a way that might trigger higher Social Security taxes or Medicare premiums. The donation can count as part of the donor's Required Minimum Distribution, the amount one has to withdraw annually, as long as it is withdrawn first.


Because of the late-year extension, Congress allowed 2010 rollovers to be made as late as Jan. 31, 2011. The problem: Many taxpayers who wanted to make these rollovers had given up hope of an extension and already taken withdrawals for 2010. The IRS has confirmed that there isn't a way to rescind those withdrawals and make a charitable rollover that satisfies the RMD, so these taxpayers are out of luck.


Sales-tax deduction


For 2010 and 2011, lawmakers also extended a deduction for state and local sales taxes in lieu of a deduction for income taxes. Although it is available to all who itemize, it is primarily used by taxpayers who live in states without an income tax, such as Florida, Texas, Nevada, Wyoming, South Dakota and Washington.


According to Jamie Yesnowitz, a state tax expert with accounting firm Grant Thornton in Washington, taxpayers who use this deduction don't have to save every last receipt. The IRS provides a calculator (at giving a deduction based on income and ZIP Code, to which taxpayers can add the specific tax on big-ticket items like a boat, RV, car or airplane. Those whose state income-tax payments are low also may want to check out this deduction, he says, especially if they bought a big-ticket item during the year.


Expanded adoption credit


For tax years 2010 and 2011, the $13,170 tax credit for out-of-pocket expenses for legally adopting a child now is refundable -- meaning eligible taxpayers can get a check from Uncle Sam even if they owe no tax. This credit phases out for filers with incomes above $182,520, and adoption papers must be filed with the return. For more information, see the instructions for form 8839.


Higher-education expenses


Also extended were two higher-education benefits. Taxpayers may now take a 2010 deduction for as much as $4,000 of higher-education expenses for couples earning up to $130,000 (singles: $65,000).


For many students and their families, however, the American Opportunity Credit will be a better break, because it is a dollar-for-dollar credit of up to $2,500 per student per year, and the income phase-out is higher -- up to $180,000 for joint filers (singles: $90,000). This credit was set to expire at the end of 2010, but has been extended through 2012.


More from The Wall Street Journal and MSN Money:


Mar 24, 2011 3:59PM

I tried e-filing on the IRS website last year.  There was some sort of a glitch, and my return wouldn't submit.  I ended up printing it out and sending it in anyway.  I also don't like the fact that if you use the IRS site, an independent company, not the federal government, stores your tax information.  How many times have we all gone that route with our credit cards, when the files of outside companies are hacked.


My returns are fairly simple and I've been doing them myself for years.  While I'm very computer literate, it takes me much less time to do them myself than it takes using a program like Turbo Tax.  Plus, by mailing in my returns, my only cost is the price of a few stamps, as I don't qualify for Free File.

Mar 24, 2011 7:04PM
In 2009 it cost the IRS only 19 cents to process an e-filed return, compared with $3.29 for one on paper.
Yet, for many filers, the IRS charges to e-file. The primary reason I file on paper is because it is free to me.

Hmmm the government paid over $5 billion dollars of bills the post office racked up last year and could not pay. Seems the least they could do for the bail out would be to deliver the instructions and forms this year.


Another blow to the Post Office. The old America is surely dying.

Mar 28, 2011 8:22PM
"The paper return requested direct deposit of the refund to a U.S. bank, but the IRS overlooked it and mailed a check to Singapore."


I had something like that happen. A looong time ago when I did my last paper return, I requested direct deposit. I never got it. I eventually called to check and make sure they didn't send it to the wrong account. They had the correct account information on there but for some reason had it identified as me wanting to have the refund applied to the next year's taxes. I asked the lady why in the world I would give direct deposit information if I just wanted it applied to the next year's taxes. She said she didn't know; people do a lot of weird things. I told her, no, you guys didn't mark it right. I'm staring at a copy right now and I did NOT check that option. I eventually got it but it was months later. No penalties and interest.
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