States Lag Federal Government in Electronic Tax Filing

The number of state income tax returns filed electronically still lags behind the federal e-file rate in all but three states, despite states’ efforts to encourage taxpayers to move away from paper filing.

This gap, which exists everywhere but Kansas, Massachusetts and Ohio, remains even after a decade of double-digit growth in the electronic filing of state returns, which is more efficient for state governments and saves money. And experts predict that the number of electronic filings could plateau unless more states offer innovations, such as allowing taxpayers to check the status of their refunds online and requiring certain returns to be filed electronically.

About 44.4 million — nearly one-half — of all personal state income tax returns were filed electronically in 2004, compared to about 49.4 million federal returns – a gap that experts say states could have difficulty closing. Although state filing deadlines vary widely, many taxpayers file their state taxes in conjunction with the federal government’s April 15 deadline.

Iowa, where about 60 percent of state returns were filed electronically last year, leads the nation in e-filing, followed by Minnesota, California, Georgia, Michigan and Arkansas, according to a recent report from the Federation of Tax Administrators. More than half of the returns in each of those states were filed electronically, though that was still below the rate of federal e-filing.

Just five years ago, paper returns accounted for 80 percent of all state personal income tax filings; by last year that had dropped to 49 percent. Much of the effort to move away from paper filing was due to state budget woes.

“A lot of growth in electronic filing occurred when states didn’t have any money,” said Harley Duncan, executive director of the federation. “When the recession hit, there was a push to move to electronic filing because that takes paper out of the system, requires fewer people and helps save money.”

But further gains in electronic filing are expected to be harder for states to come by, especially because they have already captured the computer-savvy taxpayers who are inclined to file electronically. “Without some further incentives, that growth is going to slow rather substantially,” Duncan said. “It’s just getting harder to attract new people to the game by using the old method of trying to market it.”

Duncan cited Indiana and Virginia as places where some new methods are being tried. In those states, for example, taxpayers can check the status of their state income tax refunds online.

Across the country, there are various means of filing returns electronically, including by personal computer using various commercially sold software programs, by state-run Web sites in 24 states and by the Internal Revenue Service. Non-paper returns also are filed by phone.?

Ten states now require some tax preparers to submit returns electronically, and three-fourths of states also now offer electronic filing for sales and business taxes. Corporate income and payroll taxes are next on states’ agendas, Duncan said.

Most states now offer residents the option of having their income tax refunds directly deposited into their bank accounts, adding another level of efficiency and cost-effectiveness to the process.

“Just like the electronic filing, it’s quicker, easier and cheaper,” Duncan said. “It cuts down printing and mailing costs and printing and mailing time. It gets the refund to you three to five days quicker than you’d otherwise get it.”