Why Are Millions Paying Online Tax Preparation Fees When They Don’t Need To?

As internet use took off at the turn of the millennium, the Office of Management and Budget asked the Internal Revenue Service to create no-cost electronic tax-filing options for low- and moderate-income taxpayers. The tech-challenged agency turned to the online tax-preparation industry for help and soon struck a deal with companies such as Intuit (the maker of TurboTax) and H&R Block, which had organized as a 12-member consortium called the Free File Alliance.

The Free File Alliance agreed to offer tax-prep service to millions of Americans at no charge. In exchange, the IRS pledged to “not compete with the Consortium in providing free, online tax return preparation and filing services to taxpayers.”

The arrangement went into effect in 2003 and the IRS and the alliance have kept the framework in place ever since. Today the Free File system appears on track to become permanent. In April, the House voted unanimously to enshrine the provision in law, and the Senate is now considering whether to follow suit.

It’s hard to argue with the goal of the program. Free File theoretically allows 70 percent of American taxpayers to prepare and file their taxes at no cost. More than 50 million no-cost returns have been filed using the program over the past 16 years, according to the IRS, saving users about $1.5 billion in fees. Intuit lauds the program as “an example of a public/private partnership that works.” And Tim Hugo, executive director of the Free File Alliance, called Free File “a great product,” adding, “Free File has changed the market.”

But 50 million returns over 16 years represents only about 3 percent of eligible tax returns. By ProPublica’s estimate, that suggests U.S. taxpayers eligible for Free File are spending about $1 billion a year in unnecessary filing fees.

A key reason for the anemic usage, according to experts, is that many taxpayers are unaware of the program. “I don’t have an advertising budget,” said Hugo, who acknowledged the lack of awareness. He argued that it’s the IRS’ responsibility to publicize the program. “The companies are already donating the services. It’s a philanthropic endeavor.”

Critics say low usage is exactly what Intuit, H&R Block and others are seeking. The tax-preparation companies “want the status quo,” said Nina Olson, the national taxpayer advocate, whose role is to be the voice of taxpayers inside the IRS. The agreement with the companies not only keeps the federal agency from developing a direct filling option, but also an automated “return-free” option in which the IRS would calculate most individuals’ taxes. A 2013 ProPublica investigation found that the industry has successfully lobbied against such a system.

Another reason few taxpayers use Free File is that finding and understanding the options can be confounding. “Trying to navigate the Free File sites,” Olson once said in congressional testimony, is “a bit like living in the Wild, Wild West.”

Tax-preparation companies sometimes complicate the matter by using confusingly named products. Intuit, for instance, has a “Free Edition” of TurboTax, which handles federal 1040EZ or 1040A forms gratis — but charges for state forms. It also offers a “Freedom Edition,” which is the Free File version and handles both federal and state forms at no cost. Intuit acknowledges the discrepancy in its support pages: “don’t confuse Freedom Edition with Free Edition at TurboTax.com. These similarly-named products are completely different.”

Moreover, the Freedom Edition isn’t visible on TurboTax’s homepage. Indeed, only one of the 12 Alliance members, Free Tax Returns.com, prominently displays the Free File option on its homepage. If you know to look for those pages, you can find them via a web search. You can also discover the options via IRS.gov. Otherwise, Free File is extremely difficult to find.

Adding to the confusion is an array of eligibility requirements that differ among providers. This year, for example, TurboTax makes Free File available to anyone who earns less than $33,000 or qualifies for the earned income tax credit. H&R Block’s version covers incomes of $66,000 or less, but only for people 50 or younger. Other companies have other requirements, which generally vary by income, age and state of residence. (The alliance coordinates the requirements among providers in such a way that, in theory, 70 percent of taxpayers will be eligible for at least one offering.)

The tax-prep companies insist their Free File offerings are easy to find and understand. “It’s not hidden,” said Timur Taluy, CEO of FileYourTaxes.com. “There’s a link on our landing page to Free File.” But when I asked Taluy to locate the link on my phone’s browser, he couldn’t. He ended up finding the page using a Google search. Still, Taluy asserted that “a lot of people know that Free File exists and they make conscious choices to use another free service or a paid service.”

Amanda Werner, a cheesemaker from Vermont, said she discovered Free File this year when she happened to receive an email from her local United Way that mentioned it. She said she immediately switched and was pleased with the program. Her only regret is that she didn’t know about it earlier, which meant she was previously paying H&R Block between $20 and $60 per year for tax prep. “[It] left me mildly annoyed that I’d had to pay for the same service in the past,” she said. Other taxpayers interviewed for this article also paid fees to online tax preparers, only to learn that they would have been eligible for Free File. (One of those taxpayers was then able to persuade TurboTax to refund the $89.98 in fees they had spent on this year’s return.)

Determining exactly how many taxpayers are eligible for — but not using — Free File is almost impossible. The IRS said it does not have data on filing fees paid by taxpayers and none of the Free File Alliance companies would provide it. “It’s not totally advantageous for us to share all of that information,” said a representative for TaxAct.

Still, a very rough approximation is possible. About 53 million returns were filed using do-it-yourself online or downloadable software last year, according to IRS data. Free File is meant to cover 70 percent of taxpayers, or about 37 million among the DIY returns. But only about 2.5 million people actually utilized Free File, leaving some 34.5 million eligible taxpayers that potentially incurred fees. Using what the IRS calls a “conservative $30-fee estimate” for each return, that would translate to around a billion dollars in avoidable preparation and filing costs. (That estimate doesn’t include fees to file state returns. It also doesn’t capture taxpayers who paid an offline preparer, though about 3.5 million of those people used other no-cost government programs, such as Volunteer Income Tax Assistance and Tax Counseling for the Elderly).

An Intuit spokesperson contended in an email that it’s “irresponsible” to estimate the avoidable costs. He said that some customers could be choosing to use a paid product instead of Free File. He added that many customers also get no-cost returns via products such as TurboTax’s now-discontinued AbsoluteZero product, Credit Karma (which says it handled more than a million returns this year) or similar offerings from other companies. Any accurate calculation, the spokesperson argued, depends on knowing exactly what products consumers choose to use and how much they end up paying. When ProPublica asked for such information on TurboTax customers, he cited “competitive reasons” for not sharing data. “I implore you to do the due diligence to be factual rather than estimate for effect … or people with the data may pop up after the fact,” he wrote. “You could be left holding the bag.”

For its part, the IRS believes it’s doing everything it can to make Free File successful. “We feel like we do promote Free File fairly heavily,” said Ken Corbin, the IRS’ commissioner for wage and investment, which oversees the program. Terry Lemons, the IRS’ chief of communication and liaison, adds that the agency has its own budget woes to contend with. “There’s a lot of demands, and we’ve got fewer resources.”

The IRS says it once had $1.5 million a year to promote Free File, but that funding was eliminated in 2015. The agency also claims that budgetary constraints kept it from implementing a 2007 inspector general recommendation that the IRS better evaluate Free File, including more closely surveying taxpayers who aren’t using it.

Some critics argue for drastic change. “The program has to be radically reconceived” if not eliminated altogether, said Dennis Ventry, a tax-law professor at the University of California Davis and chair of the IRS Advisor Council. He says the council is currently looking into Free File and will present its recommendations in November. Ventry expressed concern about companies up-selling products and obfuscating Free File user agreements, among other issues.

The Free File rules are laid out in a memorandum of understanding between the IRS and the Free File Alliance. The memorandum, which is renegotiated every few years (the current version runs through 2020), is “incredibly favorable to the industry,” according to Ventry. “The IRS let it be that way.”

Clauses prevent the IRS from collecting certain data and limit the agency’s ability to disclose any “deficiencies” they might find in the Free File system. The agreement also gives the tax-prep companies an opportunity to “intervene” in relevant Freedom of Information Act requests posed to the IRS.

“It’s amazing how much the companies dictate the rules,” said one industry insider, who asked for anonymity given the sensitivity of the subject. Free File Alliance members acknowledge the threat of government entrance into the marketplace in recent SEC filings, calling the possibility “a continued competitive threat to our business” that “could potentially have material and adverse revenue implications.”

Dozens of other countries, from the United Kingdom to Japan, have ways for at least some taxpayers to electronically file directly with the government. But according to Olson, the National Taxpayer Advocate, the U.S. has never really explored what such a system might look like. She argued that current programs such as Free File should be re-examined. “What I believe Congress needs to do is to have a conversation about why taxpayers aren’t using it,” Olson said. “What do taxpayers want?”

Congress has overwhelmingly supported Free File. “It’s a great program that helps save the government money and do free tax filings for people who can’t afford it,” said a spokesperson for Rep. Peter Roskam, R-Ill. Roskam introduced bills to make Free File permanent in both 2013 and 2017. Records show that H&R Block and Intuit lobbied in favor of the latter effort.) When asked about potential issues with, or improvements to, the Free File program, Roskam’s spokesperson replied, “we don’t have anything to contribute to your article.”

Free File bills never made it very far on their own in the past. This spring, though, the idea was rolled into a broader IRS reform package known as the “Taxpayer First Act,” which includes a variety of provisions aimed at improving customer service, beefing up cybersecurity and assuring proper notice before asset seizures. That bill passed the House in April 414-0.

Now it’s the Senate’s turn to debate its approach to IRS reform and, consequently, the merits of Free File. Although the provision has generally seen support, it does have at least one outspoken detractor. “Doing your taxes shouldn’t be this hard — or this expensive,” said Sen. Elizabeth Warren, D-Mass., who has introduced legislation calling for a “return free” filing option.

Intuit is sticking by Free File, as is H&R Block. The latter provided a statement, asserting that taxpayer feedback on Free File “is overwhelmingly positive,” and adding, “we are proud to have helped millions of Americans file their returns under this program.” Intuit said it began providing no-cost tax preparation service to low-income taxpayers in 1998 and that it has spent millions of dollars to support and promote no-cost services such as Free File and Volunteer Income Tax Assistance. Most recently, the company says it put $1.5 million into a new campaign to promote no-cost filing known as Tax Time Allies. Still, Intuit acknowledged “there’s room to do more.”