Taxpayers embrace e-filing, but much remains unknown about how the new technology affects IRS

Tax preparation and filing is moving increasingly online, offering benefits to both the taxpayer and to the government, but the IRS so far knows little about the accuracy, reliability or safety of this new industry and infrastructure, according to the Government Accountability Office.

“Commercial tax software, which is used by tens of millions of taxpayers, is a critical part of the tax administration system and a potential tool for increasing electronic filing,” GAO said in its report to the Senate Finance Committee. “However, IRS does not identify which software packages taxpayers use or have information on the correlation between particular packages and compliance.”

The IRS agrees that the agency should gather information on what effect the pricing of software packages has on their use, better monitor the software industry’s compliance with government standards and perform an assessment of possible risk of software use. “Without a risk assessment, IRS does not know whether its existing investment in oversight of the tax-software industry is too great, about right, or needs to be expanded,” GAO said.

In 2007, the latest year for which IRS figures were available, 81.5 million tax returns were filed electronically, nearly 60 percent of the total. These included returns filed by paid preparers as well as those filed by individuals using online services or retail software. The IRS cannot receive electronic returns directly from individual taxpayers. Returns filed from home computers using software products are sent to authorized electronic filing providers that submit them to the IRS.

Electronic returns have a higher accuracy rate than manually prepared returns, take half the time to process and are cheaper to process. IRS estimated in 2005 that the cost of processing an electronic return was about 35 cents, compared with $2.87 for a paper return.

“This volume makes commercial tax-preparation software a critical part of the tax administration system,” GAO said. “It is in IRS’ best interest to ensure that taxpayers can rely on commercial software to make electronic filing easy and efficient.”

But IRS has little information about the market and how pricing of the software and services affects their use by taxpayers.

Three packages — TurboTax, TaxCut and TaxAct — account for an 88 percent share of individual users, which would simplify the task of studying the market, GAO said. The software for all three is offered for retail sale, by download or as an online service. Prices for software packages this year range from $90 to $160 for TurboTax, from $70 to $100 for TaxCut and from $22 to $53 for TaxAct. Prices for online services are lower, ranging from $26 to $110 for TurboTax, from $30 to $110 for TaxCut and from $14 to $17 for TaxAct.

Are the request of the IRS, companies are eliminating the separate electronic filing fee with the software packages, bundling it in with the cost of the software. But there is no information on whether this encourages electronic filing by eliminating the separate fee, or discourages use of the software because the fee is not included in a higher price for the package.

“IRS has an opportunity to study whether this and other changes are effective in increasing electronic filing,” GAO said. “Additionally, IRS would benefit from being able to identify which software package the taxpayer used to better target research and efforts to increase software use and electronic filing.”

IRS requires tax software to pass the Participant Acceptance Testing System, to verify that the tax-code data and calculations are accurate and interoperability with IRS systems for electronic files. But the agency does not have a formal system to monitor compliance, and the program does not evaluate how good a job the software’s guidance for taxpayers is.

“If even small improvements in the accuracy of tax returns could be made by clarifying the guidance in tax software, the effect on revenue could be substantial,” GAO said.

This year, IRS suggested that vendors providing electronic filing service use a new set of privacy and security standards developed by the agency. The standards are voluntary because they were not completed until late last year, but the agency is considering making them mandatory for the 2010 tax filing season. GAO recommended that IRS develop and implement a plan for monitoring compliance with these standards next year.

The current recommended standards are:

• Providers must possess current and valid Secure Socket Layer certificates that use strong validation and specific SSL versions and types of encryption.
• External network vulnerability scan run by an independent certified third-party vendor weekly in accordance with the Payment Card Industry Data Security Standards.
• Information privacy and safeguard policies will be written consistent with the applicable government and industry guidelines and include “we maintain physical, electronic and procedural safeguards that comply with applicable law and deferral standards.” This compliance shall be certified by a privacy seal vendor acceptable to IRS.
• Web site-challenge-response test (e.g., Completely Automated Public Turing Test To Tell Computers and Humans Apart) shall be implemented.
• Public domain name shall be registered with a U.S. registrar accredited by Internet Corporation for Assigned Names and Numbers and must be locked and not private.
• Security incidents must be reported to IRS as soon as possible via encrypted e-mails but not later than one hour after confirmation of the incident. If the provider’s Web site is the proximate cause of the incident, the provider shall cease collecting taxpayer information immediately via the compromised Web site.