Rethinking Free File

0 Flares Filament.io 0 Flares ×

Today’s post is written by Frank DiPietro, LITC Director at Indiana Legal Services, Inc., and Sarah Taylor, a third-year law student at Indiana University Mauer School of Law. Frank and Sarah review the development of the Free File program and examine possible reasons for its extremely low take-up rate. As Frank and Sarah mention, the National Taxpayer Advocate’s 2018 Annual Report to Congress identifies deficits in the Free File program as the fourth most serious problem facing taxpayers.

One issue of concern to the NTA (and today’s guest bloggers) is the upselling of paid products. While the Memorandum of Understanding governing the Free File program has provisions designed to protect taxpayers from upselling, these protections are limited and they don’t apply to non-Free File preparers. To address this, the 2019 Purple Book includes a recommendation that Congress amend section 6713 so the Treasury Department could write regulations designating the “use of tax return information for certain questionable business practices or the sale of certain products with high abuse potential as civil violations without also making them criminal violations.” Christine

On January 28th, tax filing season officially began. It is estimated by the Internal Revenue Service (IRS) that over 150 million individual tax returns will be filed for tax year 2018. The majority of these tax returns could be prepared and filed electronically for free. According to the Free File, Inc., formally Free File Alliance (Alliance), an organization composed of the largest tax preparation software companies, 70% of taxpayers are eligible to prepare their tax returns and file electronically for free. However, it is estimated that only 3% of those eligible will utilize this service. This post evaluates some of the reasons the Free File program has failed to provide free online preparation and filing for the majority of taxpayers and suggests alternative approaches to addressing the tax preparation needs of the most vulnerable taxpayers.

read more...

The IRS and the Free File Alliance (members include H&R Block, Intuit, Liberty Tax) entered into a memorandum of understanding (MOU) in 2002 to allow financially eligible taxpayers to prepare and electronically file tax returns using Free File Alliance members’ tax preparation software for free. Section 2004 of the IRS Restructuring and Reform Act of 1998 (RRA ’98) mandated that the IRS develop a return-free tax system under which eligible individuals could comply with their filing obligations without preparing a tax return for all returns filed after December 31, 2007. However, in a 2003 report to Congress, the Secretary of the Treasury stressed that such a system would not be feasible without a significant increase in electronic filing and may not actually reduce administrative costs or compliance burdens for low- to middle-income taxpayers. Instead of developing the return-free system Congress envisioned, under the direction and guidance of the Department of the Treasury and the Office of Management and Budget, the IRS entered into the Free File MOU with an intention to increase access to online tax preparation software and free electronic filing options. Yet, over 15 years later, almost all eligible taxpayers still pay tax preparation and electronic filing fees, use of the Free File program is actually declining, and the Secretary of the Treasury has not implemented the return-free mandate for eligible taxpayers or continued to annually update Congress on its development as required by RRA ’98.

The reasons behind the failure of the Free File program are numerous. The National Taxpayer Advocate, Nina Olson, once described it as “a bit like living in the Wild, Wild West.” Each member of the Alliance (currently there are 12) has its own specific eligibility requirements, and eligibility may not be determinable until the return is started or nearly completed. Examples of these varying requirements include active duty military status, differing income and age eligibility requirements, foreign address filing, or required associated tax forms or schedules. Although the IRS website attempts to address this concern with its Free File Software Lookup Tool, the tool is overinclusive in that it only screens for adjusted gross income, age, state of residency, military service, and a self-assessment of whether the taxpayer is eligible for the earned income tax credit. The result is that many Schedule C filers or filers with complicated dependency issues, for instance, may inadvertently think they are eligible for a free version of a specific software when in fact they are not.

Unfortunately, the only way for many filers to discover their ineligibility is to first create an online account with the software company, begin entering their data, and then see if their situation is covered. For instance, H&R Block currently does not support free Schedule C preparation online. However, a taxpayer would not discover this ineligibility until attempting to enter 1099-MISC or other self-employment income data, which could happen well into the process of completing the return. In these situations, the current MOU with the Alliance requires the software company, at this point, to re-direct the taxpayer back to the IRS’s Free File website. Additionally, the company may offer to let the taxpayer continue if he or she agrees to pay to the proposed fee (H&R Block starts at $49.99 for a federal return). Thus, a taxpayer in this situation must determine whether he or she wants to restart the entire process or pay the fee to continue.

Another reason most taxpayers do not use the Free File program is taxpayers may simply not know it exists. Although an Alliance spokesperson stated a lack of an Alliance advertising budget is partly to blame for this awareness issue, a recently filed tax return (available through GuideStar.org) for the nonprofit organization suggests its revenue is steadily increasing. Regardless, according to terms of the MOU, it is ultimately the responsibility of the IRS to advertise and promote the program, and this advertising budget has reportedly been eliminated.

Additionally, unless taxpayers begin their search for the appropriate Free File software from the IRS’s Free File website, which is accessible through the IRS’s homepage, they may never learn of the different software options. A simple “Google” search for “free file” only reveals some advertisements by some of the providers, and the IRS’s website only appears below those advertisements. This can result in taxpayers directly choosing to visit a provider’s page without ever visiting the IRS’s Free File website. If the taxpayer has chosen a provider that he is not eligible for, he may not know there are other options with different eligibility requirements.

Moreover, if the taxpayer has not accessed the provider’s website through the IRS Free File website, he may never land on the “Member Free File Landing Page.” This is a critical step in the functioning of the program because only these “landing pages” are regulated by the MOU. Thus, a software provider may advertise its free filing option in any way it chooses, or not at all, anywhere else on its website, and it is not required to notify taxpayers that they are eligible for a free return if those taxpayers have selected a purchased version of the software.

Finally, the providers are not required to screen Free File eligible taxpayers who enter their websites via any method other than the Member Free File Landing Page. For instance, the TurboTax website offers new users the option of letting the website choose which software is best for them based on taxpayers selecting certain criteria that are applicable to them. But, by choosing the first option “I want to maximize deductions and credits,” the taxpayer is already disqualified for a “Free Edition” version of the software. Even though TurboTax is the leading software provider of taxpayers who use the Free File program, it is not obligated to offer its Free File software anywhere except the Member Free File Landing Page. As another example, Liberty Tax does not advertise its associated Free File software – esmart tax – on its online filing homepage or associated links, nor does it appear on its comparison of its online tax filing products.

It should be apparent by now that the opportunities available and utilized by Free File members to steer otherwise eligible taxpayers into paid versions of their software or other products are numerous. Past practices by these software providers have been well documented and reported, and they include the use of “value add” links promoting products such as audit protection services, refund advance loans, and refund transfer services, charging to file corresponding state returns even if a free filing option is available for that state, and failing to advertise or link to the company’s free file edition from its homepage.

The Internal Revenue Service Advisory Council’s (IRSAC) most recent report addressed some of these concerns, including “the IRS’s deficient oversight and performance standards” for the program which “put vulnerable taxpayers at risk.” The Free File MOU was revised to address some of these concerns, including how members may communicate with previous free file users and how products are advertised on the Member Free File Landing Page and within the Free File version of the member’s software. Additionally, in the most recent Annual Report to Congress, the National Taxpayer Advocate addresses the underutilization and lack of oversight of the Free File program as a “most serious problem” facing taxpayers. The report notes, “With no effective goals, measures, or budget, the IRS’s Free File program in its current format has become an ineffective relic of early efforts to increase e-filing.” It urges the IRS to develop actionable goals and increase its oversight of the program or otherwise discontinue its use.

Given calls for increased federal oversight, why do the for-profit Alliance members continue to offer versions of their tax preparation and filing software for free? In short, it keeps the IRS out of the tax preparation business. The current non-compete agreement, which extends the terms of the MOU until October 31, 2021, ensures Alliance members that if individuals wish to self-prepare and electronically file their tax returns for free, they must use Alliance software. During fiscal year 2017, this amounted to approximately 53 million self-prepared and electronically filed tax returns, of which only 2.5 million were filed for free using the Free File program. Given the fact that a significant majority of eligible free file taxpayers still pay, how can the IRS expect these for-profit companies to direct most of their paying customers towards a free version of their software? Also, the current partnership with the IRS and Alliance does nothing to address the return-free mandate of 1998.

The privatization of tax return preparation has created an industry fundamentally at odds with the objectives of the IRS. While the IRS wants citizens to file and pay the correct amount of tax, the software industry wants to generate its own revenue, which does not necessarily entail ensuring legally correct tax returns. For instance, in an evaluation of the various Free File software options, the Taxpayer Advocate Service noted a lack of consistency in the amount of assistance the software versions provide to taxpayers, which can result in filing incorrect returns. Additionally, scholars such as Jay A. Soled and Kathleen DeLaney Thomas have raised concerns with other features of the software, such as displaying the running refund total or balance due throughout the return preparation. Although the Free File program requires members to guarantee their calculations, it does not require any level of assistance to assure taxpayers are claiming legally correct tax positions. This feature of continuously displaying the refund may make taxpayers more susceptible to filing incorrectly in an attempt to game the system.

Realizing the regressive costs of tax return preparation on low- and middle-income individuals, Congress directed the IRS to develop a system that would allow eligible individuals to comply with their filing obligations without the need for preparing a return. One such system implemented in Mexico provides pre-populated tax returns to its citizens – also known as a type of tax agency reconciliation filing system – using cloud-based technology provided by Microsoft’s Azure. The results were that taxpayers were able to complete their returns often in a matter of minutes, and the revenue agency experienced an increase in overall revenue collections by as much as fifteen percent in a single year. This example calls into question whether a complete reliance on industry software and services as the “financial gatekeepers of the income tax system” is the most efficient method for the IRS to administer electronic tax return preparation and filing.

However, in its final annual report to Congress on the matter, the Secretary of the Treasury stressed the need for tax simplification as a pre-requisite to implementation of an American return-free system. The Tax Cuts and Jobs Act of 2017 is expected to significantly reduce the number of individuals who itemize their deductions. Treasury Secretary Mnuchin touted the simplification of the “postcard” sized new IRS Form 1040 for tax year 2018. Could this be the necessary simplification the IRS requires to finally implement the return-free mandate?

Meanwhile, the future of the Free File program is currently undecided. Both houses of Congress have offered vastly different options going forward. The House of Representatives passed the Taxpayer First Act on December 20, 2018 and referred it to the Senate. This bill would have codified the Free File program to guarantee its perpetuity. Alternatively, Senator Elizabeth Warren, along with 11 co-sponsors, presented a drastically different direction for tax return preparation in the Tax Filing Simplification Act of 2017. This act would have prohibited future agreements from barring the IRS from developing its own preparation software and would have provided for optional government preparation of individual tax returns for eligible taxpayers. Neither bill has been voted on in the Senate.

For now, however, the Free File program remains the only option for taxpayers to self-prepare and electronically file a free tax return. Without an advertising budget, it also remains one of the IRS’s best kept secrets. In its current form, an overwhelming majority of taxpayers who are eligible for Free File will never use it.

Comments

  1. The National Footwear Alliance recently completed a study of why so few people are taking advantage of its Free Left Shoe program.

    They found that the number of amputees is far less than estimated. Furthermore, many of these potential users need only a right shoe.

    Perhaps IRS could learn from this. In 43 states, people also need to file a state income tax return. The IRS website tells me,

    “State return preparation and e-file is available for free but fees may apply.”

    This is like being told you have a clean bill of health, although you are obese.

    Any discussion of Free File should start with what is being done about state income tax returns.

    Especially here in Arizona, where the 2018 state income tax law has not yet been decided. We may not know until after April 15 what deductions are left, when the governor and legislature finally agree on conformity to the new federal law. Should the IRS-sponsored coalition be taking sides now on that question?

  2. Thank you for this very concise summary.

    “We are from the government and we are here to….”

  3. I have been doing tax returns for over 14 years. EA, Ultra Tax, Drake. A couple of years ago, being between jobs I thought why buy Turbo Tax, Timothy Geitner’s cadillac program, when IRS will do it for free. Bad experience from the get-go. Startup was almost scary. Finally I realized was not dealing with the IRS, but had to pick on one of several “commercial” programs. Oh, yeah, like which one? Did so, until it kicked me off – this program could not handle my return Go elsewhere. (I believe I was offered a program that would work if I wanted to pay for it.) Did not like the second program. It didn’t kick me off, but I didn’t think it was asking all the questions it should have. (Experience was getting in the way). Here is the problem. The “big boys” are controlling this. I am sure they are claiming it is not fair for the gov to provide a free program that competes with them. So what you offer to the public is a mish-mash of junk. You know the IRS could set up one program that would handle any situation (how about a 1031 exchange for example), run it through their computers, and bingo. The program would open with tell us your name address and SSN, and go from there, right down Sch 1, Sch 2, Sch 3, etc. I say what they had 2 years ago would fall under the heading of “crap”. I don’t know if it is any better this year, but I won’t be finding out. I’ll be buying Turbo Tax for $79.99 at Sam’s Club.

Comment Policy: While we all have years of experience as practitioners and attorneys, and while Keith and Les have taught for many years, we think our work is better when we generate input from others. That is one of the reasons we solicit guest posts (and also because of the time it takes to write what we think are high quality posts). Involvement from others makes our site better. That is why we have kept our site open to comments.

If you want to make a public comment, you must identify yourself (using your first and last name) and register by including your email. If you do not, we will remove your comment. In a comment, if you disagree with or intend to criticize someone (such as the poster, another commenter, a party or counsel in a case), you must do so in a respectful manner. We reserve the right to delete comments. If your comment is obnoxious, mean-spirited or violates our sense of decency we will remove the comment. While you have the right to say what you want, you do not have the right to say what you want on our blog.

Leave a Reply to L Carpenter Cancel reply

*