This year more than three-fourths of all individual tax returns will be filed electronically, and a growing number will come from people who used tax-preparation software. As modern and efficient as this is, the law has not caught up. Taxpayers who employ an accountant or other preparer have some protection from daunting penalties if the IRS finds mistakes. Software users who prepare their returns without help have little or no protection.
The most famous software fiasco had a very atypical ending. During the confirmation hearings of Treasury Secretary Timothy Geithner three years ago, we learned that he failed to pay self-employment tax on income from the International Monetary Fund. Mr. Geithner partially blamed the oversight on the TurboTax software he had used, claiming it wasn't formatted "in a way that caught" his embarrassing mistake.
This excuse is now memorialized in tax lore as the "TurboTax defense." The IRS waived all penalties against Mr. Geithner—a waiver not customarily offered to ordinary taxpayers, who routinely face a 20% accuracy penalty (plus interest) on back taxes.
Mr. Geithner's episode notwithstanding, there's a growing issue here. Taxpayers who utilize a professional tax adviser such as a CPA or attorney can often avoid IRS penalties by alleging reliance on the tax adviser. (You're always responsible for the underlying tax itself and any interest on the amount.) But for someone who uses commercial software to prepare returns, no such defenses are generally available: The software isn't considered to be a "professional tax adviser." That's unfortunate, because growing numbers of Americans may end up with Mr. Geithner's the-software-did-it problem.
So far the U.S. Tax Court has nearly always rejected the TurboTax defense. Only two cases have offered taxpayers penalty relief for software reliance. ... Given the dramatic changes in tax-preparation, common sense suggests that taxpayers deserve some relief from IRS penalties levied as a result of software error. It's time for the TurboTax defense to become a legitimate legal defense.