Are you ready to let the IRS do your tax return?

10/21/2012

Most of us grumble about filing our income tax returns every year. But what if the IRS instead prepared your return for you and just told you how much you owe or will get back?

It's an idea that has been gaining momentum within the Internal Revenue Service as a way to thwart tax evasion and curb identity theft.

It's called the "real-time tax system," and it would work essentially like this:

• "Information from employers, banks, investment firms, and others would be fed electronically to the IRS throughout the year, perhaps every quarter.

• "Sometime after Dec. 31, that information would be compiled and matched with Social Security numbers.

• "The IRS would then prepare income tax returns for everyone and send out a pre-completed return detailing how much you will get back or how much you owe.

• "If you disagreed, you could challenge the IRS.

At the center of the issue is the IRS' attempt to collect some $400 billion that people owe but don't declare every year and $5 billion a year that is sent to thieves who steal people's identities to file returns and get refunds.

The real-time tax system might help address both these problems to some degree, experts say, but also would delay refunds, would cost money to launch, would be a huge inconvenience to many smaller businesses, and could create more red tape for consumers who have deductions like charitable contributions and property taxes.

"The IRS has been trying to go in this direction," said certified public accountant Howard Kass of Zinner & Co. in Pepper Pike, Ohio. He noted that the agency is doing more and more "matching" -- comparing income reported by individuals and what is reported by their employers.

You'd be hard-pressed to find anyone -- even at the IRS -- who would say the current system works really well.

However, an overhaul that involves the IRS preparing our returns is going overboard, Mr. Kass said.

"You have to use a scalpel where appropriate, not a sledgehammer," he said.

Some sort of real-time tax system has been on the IRS' radar for years. More recently, IRS Commissioner Doug Shulman has sung its merits at almost every public appearance, including last month at a meeting of the American Bar Association.

"As some of you know, I've launched the 'real-time tax' exploratory effort to move away from the 'after the fact' business model, toward real-time upfront matching of third-party information, such as W2s and 1099s," Mr. Shulman said at the Boston meeting. "If the data on the return does not match our records, a taxpayer could be given the opportunity to correct the return before it's processed.

"My theory is that this is better for taxpayers and the overall tax system," Mr. Shulman said. "Taxpayers won't get a notice from us years after they filed their returns. This is a real game-changer as it could help ensure more accurate returns and ... it would help our efforts to combat refund fraud."

Mr. Shulman, who became commissioner in 2008, recently announced that he would resign effective Nov. 9, three days after the presidential election. It's not known what effect Mr. Shulman's departure will have on the IRS's push for a real-time tax system because it was not expected to be implemented before his term expired in March. The IRS declined to comment.

Clarke Price, president and CEO of the Ohio Society of CPAs in Columbus, which has 23,500 members, said a real-time tax system is "conceptually fine" but may be impractical for tax filers across the board.

It might work for people with super-simple returns, he said, such as those filing 1040EZs. That's about 12 percent of filers.

But it might be impractical for people with dependents, deductions, or investments and might be resisted by people who don't like the idea of the IRS being both preparer and collector.

"There is a certain Big Brother-esque dimension to it," Mr. Price said.

Certified financial planner Darrell Claytor, who has a master's degree in taxation, said a real-time system would force small businesses to electronically file W-2 information for employees instead of mailing it in, and that could be a burden for some.

The biggest glitch in the IRS' current system, he said, is that it's based too much on trust. Most of the information in a person's return is not verified until six to 18 months after the refund is issued to the filer.

"To me, it doesn't make sense to be processing refunds without having all of the supporting information," Mr. Claytor said. "The IRS is pretty much taking people's word for it until they get the W-2 information input. By then, the money is gone."

Akron CPA Doug Klein, who worked for the IRS for eight years, said he thinks a real-time system would be more feasible if we had a flat-tax system with no deductions or exemptions.

Otherwise, it might work only for people with wages but no other income, such as from investments or real estate rentals, and no itemized deductions, said Mr. Klein.

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Some changes could be unpopular.

Kass, the Pepper Pike CPA, said the notion of the IRS preparing people's returns after matching information to people's Social Security numbers is a nightmare. Even the after-the-fact matching the IRS does now is a disaster, he said.

"This has been a process that has been so fraught with inaccuracy that it's almost useless," he said. For example, if a taxpayer doesn't report the sale of stock, the IRS knows only about the gross proceeds and disregards the fact that the seller probably had a cost basis in that stock (generally meaning the original purchase price) unless that person bought and sold the stock using the same broker after 2010.

Without that information, the IRS might think someone had a $5,000 gain when it was actually a $5,000 loss, Kass said.

Price of the Ohio Society of CPAs said a system of the IRS preparing our returns could be tried on an opt-in basis, but not a mandatory basis. "There are some people who might welcome this," he said.

Any movement toward a real-time tax system could cause two unpopular changes:

First, Klein said, a staggered filing system that would involve people filing at different times of the year, perhaps based on their Social Security number.

Second, a delay in refunds, Claytor said. There's no way the IRS could issue refunds in January for a tax year that ends Dec. 31.

The IRS has never provided a timeline for trying to launch the real-time tax system.

Mr. Klein has a guess: "I'm really skeptical that the IRS prepares my return and I sign off on it in my lifetime.