The pros and cons of e-filing your taxes

Nobody likes to talk about it, but everybody knows it's here: tax season. And a big question many taxpayers face is whether to file by paper or electronically. Some taxpayers fear that if they file electronically, they will face the ultimate horror: an audit. But tax experts say that electronic filing actually can decrease the number of errors you may make.

"I haven't seen numbers to back up the IRS's contention that there are fewer errors when you e-file," says Scott Estill, a former IRS senior trial attorney and author of "Tax This! An Insider's Guide to Standing Up to the IRS." "But it's intuitive that e-filing would mean fewer errors." And as for being audited, he says, they can only audit from 1 to 1.5 percent of all returns, which means "you have a 99 percent [chance] of not being audited."

Mr. Estill hit on the crux of arguments for and against e-filing: On the one hand, the IRS contends that tax returns sent electronically are 20 percent more accurate than paper returns. Errors on paper returns can be due to inaccurate Social Security numbers, failure to sign the return, and, even by the IRS's own admission, mistakes by agents transferring handwritten information into its data systems.

"We use electronic scanning and bar codes to turn handwritten forms into electronic format," says Nancy Mathis, spokeswoman for the IRS. "Filing by hand can trigger a desk audit – a verification audit for discrepancies if you don't write legibly or if the numbers don't add up."

On the other hand, some tax preparers wonder if e-filing is the quickest route to an audit. Paper returns may sit on an IRS shelf longer. "I'm asking taxpayers to be prudent," says John Giacchetti, CPA and principal of his own tax-preparing firm in New York. "Don't sacrifice your own interests by doing what's on the Bureau's agenda, in this case, speeding your form through their systems."

Others are equally suspicious. "E-filing would increase your exposure to an audit because it's analyzed instantly for a discrepancy, whereas for manually written returns, less than half are put into this algorithm the IRS has for red flags," says Jonathan Park, who blogs at mymoneyblog.com. "You think every handwritten form is looked at? To cut corners, the IRS can't look at them all. But it costs nothing to look at something that's already in the computer."

Another argument in favor of filing through the mail goes like this: The more money the IRS saves from people e-filing – or the fewer clerks dealing with paper forms – the more money the agency has to hire new auditors.

But then again, additional auditors would help close the tax gap – the estimated $345 billion in uncollected taxes that keeps eluding the IRS due to big-time cheating and tax evasion, says William Henry Jones, senior tax manager at Marks Paneth and Shron, LLP, in New York.

Last year, 73.3 million of the 135.7 million tax returns processed were e-filed. You can also file for an extension electronically.

"TV loves to show people scrambling at the post office, running to get their forms sent before the tax deadline at midnight," Mr. Jones says. "Unless they're looking for a date or their 15 minutes of fame, I can't understand why they'd be there when you could be e-filing on your couch in your underwear."

The combination of adding direct deposit makes e-filing even better, he says. "You'll get your federal refund in a week and a half or less, and your state refund in two weeks or less."

A new wrinkle in the direct-deposit program this year lets taxpayers specify up to three accounts that their refunds can be sent to – like checking, savings, and retirement accounts. "This is great," Jones says. "It means one less thing to think about – and you can even make a painless IRA contribution this way."

Another great addition is Free File. Found on the IRS website (www.irs.gov), this free software is designed to help lower-income people feel comfortable filing their own taxes without hiring a professional tax preparer. This public/private partnership was developed by 24 providers, including the big three: H&R Block's TaxCut, Intuit's TurboTax, and 2nd Story Software's TaxACT. The service, launched in 2003, is open to most taxpayers making $52,000 or less. "This offers 70 percent of the nation's taxpayers – 95 million people – a way to e-file," says Ms. Mathis at the IRS.

This year, participating companies agreed to remove offers from their tax software that, for a fee, would advance taxpayers the amount they anticipate in a refund. "We wanted to be able to say, 'Free is truly free,' " says Bert DuMars, director of electronic tax administration for the IRS, in a telephone press conference. For some people, the ads for the loans "tainted Free File in some way."

"The income could have been capped at $100,000 for Free File," laments author Estill. "But it was the lobbying by tax-pro behemoths that prevailed on Congress to put the limit at $52,000, complaining that if Free File took in too many folks, it would cut into their business."

The largest growth in e-filing is among those who prepared their own returns, says the IRS's Mathis. Some 20.3 million such taxpayers used e-file last year, a 19 percent increase over 2005.

The ability to use software and e-file free of charge pleases some taxpayers. "I don't think that e-filing would any more or less trigger a red flag," says Joseph Puma, an IT director for Sandler Capital Management in New York. Mr. Puma has already filed his 2006 taxes using the online version of TurboTax. "The software shows if you've made errors so you can correct them – and it corrects others for you." He adds that the TurboTax's protections guarantee – that calculations are accurate – makes him feel secure enough that he isn't concerned about audits.