IRS free filing program troubles commercial vendors

As more taxpayers turn to the Internet to file tax returns, an agreement between the Internal Revenue Service and commercial tax-preparation vendors has come under fire by some vendors that say the IRS' free file program has strayed from its intent and unfairly competes with the commercial marketplace.

In a June 1 meeting between the IRS and the 20-member Free File Alliance (FFA), which make e-filing services available for free to individuals with "a modest income," the IRS attempted to soothe industry concerns. The agency tabled two proposals aimed at balancing taxpayer and industry interests that have pitted small vendors against large, multi-service firms. One proposal would cap free services at a $75,000 household income level, while the other would set a threshold of 70 percent of the population, according to industry sources. The IRS declined to comment on the specifics of the current negotiations.

The IRS' free online tax preparation and electronic filing program has prompted charges that its goal to offer taxpayer services while leveling the playing field for vendors has done exactly that -- provided a system for all vendors to maximize consumer choice. Some 20 vendors now offer free online tax-prep services, which best serve those with uncomplicated returns.

"It was designed to be a program for the low income. It should stay true to its mission," said Daniel Johnson, technology counsel with the Computer & Communications Industry Association (CCIA), which does not like the idea of a cap. CCIA members include tax-preparation vendors Braman Tax Services, EFile Tax Returns, FileYourTaxes.com, Intuit and TaxSlayer.

Of the 66.6 million tax returns filed electronically for the 2004 tax year, 5 million returns were filed under the IRS' Free File program, said Bert DuMars, director, electronic tax administration at the IRS.

"We don't want it creating a business model of its own, which is what it has done," Johnson said.

Under a 2002 agreement between the IRS and the FFA, the IRS agreed it would not develop its own tax software in return for the private sector's pledge to offer free services to 60 percent of all taxpayers.

But CCIA members said in a 2004 letter to the IRS that the program "has expanded over the past two years beyond its original purpose," thus producing unintended consequences for industry. Furthermore, "The IRS Free File program will serve as a de facto program of universal free online preparation services in competition with the commercial marketplace for electronic tax services," unless it reverts to what it considered the original intent of serving low-income and underserved taxpayers. Intuit's 2004 annual report said the FFA "has caused us to lose revenue opportunities for a large percentage of the tax base."

But in a surprise move by Intuit in mid-January, the company removed its own minimum threshold and offered free services to 100 percent of taxpayers -- a move that was quickly followed by the company's chief competitor, H&R Block.

Intuit's move "violated the 'original spirit' of e-filing for the underserved," said H&R Block spokesman Tom Linafelt. "In order to remain competitive, we had to match the offer."

The goal of the program is to "maximize the availability [of e-filing] for taxpayers," DuMars said, while ensuring a "healthy tax-prep industry."