Fewer taxpayers took advantage of the Internal Revenue Service's free electronic tax return filing service in 2007 than in previous years, according to a new audit report released by the Treasury Inspector General for Tax Administration.Moreover, the audit identified multiple calculation errors made by the commercial software of Free File Alliance firms.

The Free File Program allows taxpayers who meet certain requirements to electronically prepare and file their income tax returns free of charge.

In 2005, a record 5.12 million taxpayers used the Free File Program. That number fell to 3.9 million in 2006, in large part due to a new requirement that limited eligibility for the program to taxpayers with adjusted gross incomes of about $50,000 or less. Roughly 93 million people were eligible for the program.

In testimony before the House Ways and Means Committee's Oversight Subcommittee last year, TIGTA Inspector General J. Russell George expressed concern about the eligibility limitations, which he said could contribute to a slowing of e-filing growth.

Although no further adjustments were made to the program for this past filing season, as of April 14, 2007, auditors found that only 3.3 million taxpayers filed returns using the free service - a decline of 4.7 percent below the same period last year.

The decline in the Free File Program comes at a time when the IRS is under pressure to increase the number of taxpayers who file electronically.

In 1998, Congress established a goal for the IRS to have 80 percent of all federal tax and information returns filed electronically by the end of 2007. The Free File Program was one of several initiatives designed to meet that goal.

The IRS established the alliance in 2003 as a partnership with a consortium of tax software providers. In exchange for providing free online tax return preparation and filing services through the IRS Web site, the agency agreed that it would not pursue the creation of its own online tax prep offering. Currently, the FFA's Web site lists 18 member companies.

"It is imperative that the IRS carefully examine the reasons this free service is not being used by more taxpayers," said George. "The IRS must review its marketing strategy to better target taxpayers who file paper returns even though they are eligible for this program. Equally important, the IRS must ensure that the software it promotes on its Web site provides taxpayers with accurately calculated tax returns."


Both Senators Max Baucus, D-Mont., and Charles Grassley, R-Iowa, chairman and ranking member, respectively, of the Finance Committee, expressed concern over the report.

"When the IRS refers taxpayers to an online filing service, those taxpayers have a right to expect accurate tax preparation. If the IRS really doesn't have the authority to require its Free File partners to get the software right, then they've got a bad agreement with these companies that doesn't protect taxpayers as it should," said Baucus. "At a minimum, the IRS needs to provide better assurance that Free File tax software can handle the most basic tax scenarios. But this report underscores the need for a direct filing portal on the IRS Web site, where the agency makes certain that the tools supplied to taxpayers comply with the Tax Code."

"This is frustrating for Congress and taxpayers alike," said Grassley. "We're in the digital age. We have cameras on our cell phones. We have BlackBerries. But we can't get a free electronic filing option for taxpayers to work right. Some of these software programs can't properly compute a tax return using common, basic scenarios. Reliability and accuracy are a problem."

"Taxpayers have every reason to question whether they'd be better off with a pencil and an abacus than using the current Free File program," he continued. "That has to change. Taxpayers should have the option of a free, accurate way to file their taxes electronically. Congress and the IRS need to ride herd over the software companies, ensure corrections of flagrant problems, and make this program work."

Current tax software is held to a minimum standard, and the TIGTA agreed that testing all software for compliance with all laws is not feasible. But the TIGTA concluded that the IRS could easily test software used as part of the Free File Alliance for common tax scenarios, just as the TIGTA had done during the audit using limited resources.

Atilla Taluy, chief executive of Oxnard, Calif.-based FileYourTaxes.com, agreed that tax returns filed via alliance members should be accurate. "Tax returns filed through Free File should be correct," he said. "It's good for the taxpayer, for the government and for us. Taxpayers are entitled to fair and accurate preparation when they're voluntarily complying with the tax law."

However, Taluy, whose company was a charter member of the Free File Alliance when it started in 2003, noted that his own figures showed little change from last year. "Our own numbers were within 1 percent of last year," he said. "The difference is so minute that we consider it to be about the same. When you look at the amount of competition that has started because of Free File, we think it has done very well in maintaining its position. The way that the IRS markets it is something we can't control, but we would like to see an enhancement in their marketing efforts."

IRS management agreed with four of the TIGTA's five recommendations. It will develop a comprehensive marketing plan and will consider surveying eligible taxpayers who were either unsuccessful or chose not to use the program. The IRS will also expand its marketing of Free File by directing promotional materials to eligible taxpayers who filed their returns on paper. Finally, the IRS indicated that it would work with the alliance to analyze the Free File Indicator, and would identify possible solutions to increase accuracy and establish a process to assess the indicator's accuracy early in the filing season.

The IRS did not agree with the TIGTA's recommendation to test the software used in the program to ensure that common scenarios are being handled accurately. It said that it already reviews the accuracy of alliance members' software to ensure that it operates within the parameters of the Free File Agreement, and other tests ensure that returns filed through alliance members are compatible with IRS system requirements. However, these tests do not assess the accuracy of applying the tax law.

"If there is a problem with the tax preparation industry, it shouldn't be specifically pointed toward Free File," said Taluy. "The Free File Alliance consists primarily of small businesses donating their services and capability for the American taxpayer. We don't wish to have any type of constrained marketplace. It's important that these small businesses effectively contribute and be able to sustain their existence without fear of competition by the government."

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