According to the IRS, most tax mistakes come from taxpayers filing paper tax returns. As a result, paper returns cause the lion’s share of IRS audits. Doing taxes with the help of tax preparation software avoids nearly all tax prep error.
The three most popular online tax prep software services are H&R Block Online, TurboTax.com or TaxACT.com. Each of them has a free option for federal taxes. Prices start at $9.99 for state returns with free federal returns and go all the way up to $117 for TurboTax’s deluxe state and federal tax package.
Audits: The Taxpayer’s Worst Nightmare
The IRS applies a 20% penalty to underpayment of returns resulting from tax mistakes. They also add interest at a rate of 3% for individuals for tax year 2014. During an audit, the IRS typically includes returns from the previous 3 years, and that can go as high as 6 years for big enough tax mistakes.
For an example of how bad this can get, let’s say each year someone named Jim incorrectly claims several deductions he’s not eligible for. Because of these recurring tax mistakes, he underpays his taxes by $3,000 annually without knowing he is doing it. The IRS discovers the error and looks back three years and finds that Jim’s been doing it consistently. They then decide to look an additional three years in the past, for a total of six years. Now Jim owes the $3,000 every year for six years, or $18,000. He also owes a 20% penalty of $3,600, plus interest of $2,380. That’s a grand total of $23,980, just for the one mistake repeated annually. If Jim made several more tax mistakes like this, his unexpected tax liability could be much higher.
Further, penalties can be a sky high 75% if the IRS becomes convinced someone knowingly committed fraud. The government can even tack on prison time.
Do Tax Mistakes Cause IRS Audits?
According to CBS News, nearly half of all audits are the result of simple mistakes made by taxpayers. Many more audits are caused by things that could be errors or could be knowing fraud. Errors on tax returns can include:
- Math mistakes
- Incorrect social security number
- Illegible handwriting
- Computer entry errors by the IRS
IRS Says Half of all Tax Mistakes Are Their Fault
The IRS says a full half of all tax mistakes are caused by IRS employees themselves. That’s not even a mistake taxpayers have control over. The mistakes are made when someone at the IRS enters information on a paper return into a computer. That means even if a taxpayer makes no mistakes at all, their risk of audit can still skyrocket just by filling out a paper return!
Some not-so-simple errors come from omissions or secondary mistakes, like forgetting to report a chunk of interest income or entering data from W-2 or 1099 forms incorrectly. Most tax prep software eliminates this particular type of error by importing forms directly, with no need to copy numbers manually from the forms.
Other tax mistakes include incorrectly entering deductions, incorrectly claiming deductions or credits or misinterpreting tax laws. For example, Sarah is a self-employed real estate professional who claims a deduction for her health insurance. However, the self-employed health insurance deduction is only available if the insurance plan is established under the taxpayer’s business. Since Sarah’s health insurance was set up through her husband’s employer, she’s not eligible. Her deduction in this case is therefore a mistake. If she makes this same mistake each year, she risks an audit and some hefty fines and interest.
Additionally, the IRS has no way of knowing if a discrepancy is the result of an error or outright fraud, which is why even in the case of an honest mistake, the chances of an audit jump.
Most Tax Mistakes Come from Paper Returns
The IRS reports that the error rate for paper returns is a colossal 21%, compared to an almost nonexistent .05% for tax prep software. According to an IRS bulletin, this means people are less likely to hear from the IRS when filing software-assisted returns. Further, filing taxes with the help of tax prep software is easier than completing paper returns, takes less time and results in faster receipt of tax refunds.
Use Tax Preparation Software to Avoid Tax Mistakes
The conclusion? Use tax prep software, not paper forms, when filing tax returns. There are a number of reputable online tax prep software packages that partner with the IRS, some with free and low-cost options, including:
- H&R Block
- Jackson Hewitt
- eSmartTax by Liberty Tax Service
The IRS even has a list of software packages that let consumers do their taxes for free online at: http://www.irs.gov/uac/Free-File:-Do-Your-Federal-Taxes-for-Free
Avoid Mistakes on Tax Returns
The easiest way to avoid making mistakes on tax returns is by filing online. Returns filed digitally have far fewer errors. As a result, e-filing lowers the chances of an audit. Filing online with the help of tax prep software can make the process free and easy.
- CBS News “IRS Scandal May Reduce Audit Risk” http://www.cbsnews.com/news/irs-scandal-may-reduce-audit-risk/
- IRS Bulletin: http://www.irs.gov/irb/2005-10_IRB/ar10.html
- IRS Bulletin: http://www.irs.gov/pub/irs-pdf/p910.pdf