Every year taxpayers pay $200 each on average to prepare and file their taxes, on top of any amount they may owe Uncle Sam. That’s largely because of a little-known, longstanding deal between the IRS and private tax companies, one that Sen. Elizabeth Warren (D-MA) is trying to undo.
Warren this week introduced the Tax Filing Simplification Act of 2016 that requires the IRS to set up a free tax-prep and filing service for all Americans. It also prohibits the agency from entering into agreements that restricts its ability to offer this service.
That provision runs counter to a 14-year agreement the agency has now with private tax preparation companies. In it, the IRS agrees it will “not enter the tax preparation software and e-filing services marketplace,” and, in return, the tax prep companies will offer a “free-file” program for taxpayers with adjusted gross incomes of $62,000 and below.
The agreement originated in 2002 and has been extended four separate times, most recently in 2015 for another five years, until 2020.
This deal protects a good chunk of revenue for tax prep companies from potential government competition. Last year, H&R Block made $231.8 million from fees from its do-it-yourself tax services, approximately 12 percent of its U.S. tax prep business.
TurboTax, which is owned by Intuit, made $1.8 billion in revenue from its consumer tax segment. In its annual report, the company noted how free government-run tax services could be a threat in the future.
“Our consumer tax business also faces significant competition from the public sector, where we face the risk of federal and state taxing authorities developing software or other systems to facilitate tax return preparation and electronic filing at no charge to taxpayers,” Intuit wrote. “These or similar programs may be introduced or expanded in the future, which may cause us to lose customers and revenue.”
That’s why the company has spent money to keep the Free File Alliance agreement intact. In 2013 and 2014 when the Free File Program Act of 2013 went to the House of Representative and the Senate, Intuit and H&R Block spent $9.8 million on lobbying, according to OpenSecrets.org. The site noted that the companies lobbied the most on the Free File program bill.
"Congress should be making it easier for Americans to file their taxes each year, not bowing to the interests of the tax prep industry," Warren said in a statement announcing her legislation.
Warren contends that the Free File agreement between the IRS and tax companies is in conflict with a 1998 act that required the Treasury Department to establish by 2008 procedures for the implementation of a “return-free” filing system that would calculate a person’s tax liability by using information reported to the IRS each year.
“Instead of implementing the return-free filing requirements in the 1998 IRS Restructuring and Reform Act, the IRS has time and again acquiesced to industry demands that it avoid developing return-free filing options,” states a report that accompanies Warren’s new legislation.
Additionally, she noted that the Free File program run by the tax prep companies has failed to live up to its promises. Of the 100 million taxpayers who are eligible for the service, less than 3 million used it last year, according to the IRS. H&R Block helped 676,000 taxpayers through the Free File program last year, while Intuit served 1.1 million.
Warren says part of the reason is because the companies offering the program have their own, even more selective criteria. While the IRS adjusted gross income cutoff is $62,000, TurboTax’s All Free program limits eligibility to taxpayers with AGI of $31,000 or lower (it’s higher for active service members). TaxACT’s Free File’s AGI requirement is $50,000 or lower. Others restrict by state residence, age or eligibility for the Earned Income Tax Credit.
An Intuit spokeswoman says that many taxpayers can get other free tax-prep and filing services outside of the Free File program. “There are 60 million taxpayers who have a 1040A/EZ who can use TurboTax Federal Free Edition to prepare/e-file their federal return at no cost,” Intuit spokeswoman Julie Miller wrote in an email. “Both TaxAct and H&R Block have similar offerings.” Miller declined to disclose how many taxpayers take advantage of that option.
Still, it appears that many taxpayers — even those with the easier returns that Miller identified — aren’t getting free services. The IRS found that individuals filing 1040A (which presumably could use TurboTax’s Federal Free Edition) paid on average $90 for tax-prep and filing. Those filing 1040EZ returns — the simplest return — paid $40 on average.
Perhaps the tax prep industry’s best argument against Warren’s bill is its feasibility under current conditions. While the bill calls for the authorization of necessary funds, the agency is woefully underfunded as it is. Each year from 2010 to 2015, its budget has been slashed and is down 17 percent (adjusting for inflation).
Even more relevant is the agency’s outdated technology, which would be critical in establishing a free e-filing system. Some IRS computers still run on an operating system that Microsoft no longer services. This year, an audit from the Treasury Inspector General for Tax Administration found how the IRS backs up and restores data including taxpayer information needed improvement. That comes after last year’s devastating IRS breach where identity thieves took personal data from 330,000 taxpayers to file fraudulent tax refunds.
“The system’s very creation would also be a huge burden for taxpayers,” said Tim Hugo, executive director of the Free File Alliance, made up of 13 tax software companies, said in a statement. “The IRS has cut 13 percent of its full-time workforce since 2011, and government budgets are shrinking, not expanding. The proposal would make the essential tax administration work of the IRS impossible, while disadvantaging the taxpayer."