In response to criticism from both lawmakers and taxpayer advocates who charged that its Free File Program was an entrée to sell pricey add-on offerings such as refund anticipation loans, the Internal Revenue Service announced that for the upcoming tax-filing season, its private-sector partners in the effort will remove any ancillary products from the FFP.Concerns over the Free File e-filing initiative had split Congress down the middle, with the IRS and some of the nation's leading tax software developers caught in the crossfire.

"We heard many legitimate concerns about the marketing of ancillary products during the last filing season," said IRS Commissioner Mark Everson, in a statement. "This is a constructive step."

The IRS said that outside research revealed that about 6 percent of users purchased an ancillary product from a provider, while approximately half of those said that their purchase was not intended.

The IRS established the Free File Program in 2003 in a partnership with the Free File Alliance - a group of tax software companies that agreed to provide free online tax return preparation and filing services through the IRS Web site.

Since its debut, more than 15 million returns have been prepared and submitted through Free File. Also, according to the IRS's own data, about 0.5 percent of the Free File users request a refund anticipation loan.

In October 2005, the IRS and the FFA renegotiated the agreement to continue the program through 2009, but with several key changes, including a "means test" that limited eligibility for the no-cost online filing services to taxpayers with an adjusted gross income of $50,000 or less. The new income ceiling eliminated some 39 million U.S. taxpayers from eligibility for these services, and participation in the program plunged by almost 23 percent during the 2006 filing season.

Criticism of the revised agreement had been particularly heavy in the Senate, where top tax-writing legislators from both political parties blasted the IRS for what they viewed as caving in to the tax software industry.

If anything, that criticism heightened in November, when the Treasury Inspector General for Tax Administration released a report raising fresh concerns about the program. Although the initiative was established "to provide all taxpayers a way to prepare and file their tax returns electronically without having to pay for those services," the current program "does not fully satisfy this intent."

The problems cited by the TIGTA included the fact that under the revised agreement, Free File "is limited to specific taxpayers, may be difficult for some taxpayers to use, and allows alliance members to promote products that are not always in the best interest of taxpayers."

The report suggested that the problems associated with the Free File Program might be having a negative effect on the growth of electronic filing overall. Because of the decline in participation in Free File, overall electronic tax filings increased by a disappointing 6 percent by the end of April 2006.

"In 2005, 72.5 percent of the approximately 62 million taxpayers who filed their returns on paper actually prepared their returns on computers. If these taxpayers would file electronically, the IRS could save approximately $106.7 million in processing costs," the report added.

Prior to the IRS's decision, outgoing Senate Finance Committee chair Charles Grassley, R-Iowa, blasted tax software companies for their attempts to use the Free File program to promote the add-on services. "The industry appears to be using the Free File program as an opportunity to bolster its revenue through the sale of ancillary products at taxpayer expense," he said in response to the report. "I'm all for private enterprise, but not when it co-opts taxpayer service."

At the time, Grassley's successor as chair of the Finance Committee, Sen. Max Baucus, D-Mont., also had exhorted the IRS to "take a good, hard look at the Free File program to make sure it is working effectively for honest Americans who are trying to pay their taxes."

In a joint letter to Everson, Baucus and Grassley accused the IRS of "putting the taxpayer second in line behind the tax preparation industry," adding that "the result is negatively affecting participation in the Free File Program and the overall growth of electronic filing."

Currently the IRS is considering additional changes to Free File for the 2007 filing season, and both Grassley and Baucus raised the possibility of scrapping the agency's deal with the alliance and developing a new system of direct online tax filing.

CONCERNS LEFT AND RIGHT

Suggestions that the IRS pull the plug on Free File stirred concerns in the tax software industry, as well as among a strange-bedfellow mixture of free-enterprise conservatives and left-leaning House Democrats from Silicon Valley.

Conservative groups, such as the National Taxpayers Union, FreedomWorks, Americans for Tax Reform and the American Conservative Union, are voicing strong support for the alliance - a partnership that they consider preferable to involving the federal government directly in the tax preparation process. Such IRS involvement "would represent a dangerous conflict of interest, as the tax collector and enforcer becomes tax preparer," a spokesman for FreedomWorks said in a letter to lawmakers.

Meanwhile, on Capitol Hill, a number of House members with ties to California's software industry were pushing for legislation that would counter efforts to displace the Free File Alliance.

The IRS decision also made redundant a recent bill advanced by California House Democrats Zoe Lofgren and Anna Eshoo that would have granted a stamp of approval for the Free File "means test," in return for prohibiting FFA members from selling add-on products. The bill would also encourage, but not require, members to provide state as well as federal tax prep services to eligible taxpayers.

Lofgren and Eshoo are also co-sponsors of separate legislation to protect the tax software industry by specifically prohibiting the IRS from providing "taxpayers with free individual tax electronic preparation and filing services except through the Free File program" or other existing IRS assistance programs.

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