Income limits spur drop in use of free tax filing software

Use of the Internal Revenue Service's free electronic tax filing program declined nearly 23 percent after income restrictions were applied last tax season, according to a new report from the Treasury Inspector General for Tax Administration.

Reviewers concluded that the eligibility limit and subsequent negative publicity contributed to the drop. The Free File program was available to nearly all 132 million taxpayers in the 2005 tax season, but the income cap imposed for the 2006 season eliminated about 39 million potential users, the report said. About 5 million returns were filed in April 2005 using the free online service, compared to 3.9 million in April 2006.

Overall, electronic filing increased by 6.3 percent from 2005 to 2006. But there are signals it would have grown more, had it not been for the income cap on the Free File program, the report said.

The income restrictions are included in an October 2005 amended agreement between the IRS and the consortium of tax software companies that partner with the agency to provide online filing. The agreement, which is effective through 2009, limits Free File to taxpayers with adjusted gross incomes of $50,000 or less -- about 70 percent of all filers.

The agreement with the coalition, known as the Free File Alliance, also included extra consumer protections, enhanced taxpayer data security and stronger performance benchmarks, the TIGTA report noted.

The Free File program, which debuted in January 2003 in response to the 1998 IRS Restructuring and Reform Act, grew out of the Office of Management and Budget's EZ Tax Filing effort and the Bush administration's e-government initiative. The 1998 law established a goal of having 80 percent of all tax returns filed electronically by 2007.

Inspector general reviewers said that the current program fails to satisfy the intent of OMB and the e-government initiative because it is limited to specific tax filers.

But in a response to the report, Richard Morgante, commissioner of the IRS Wage and Investment Division, wrote that the program's original intent was to provide a basic electronic filing option for taxpayers filing simple returns. It wasn't meant to provide a free service to all taxpayers, he said.

The auditors also said the program could be difficult for some taxpayers to use and allows the private sector group to promote products that are not always in the best interest of tax filers.

Members of Congress also remain concerned that Free File does not serve taxpayers' interests, the report said. Questionable advertising and fees on individual coalition members' Free File Web sites have been noted by the Senate Finance Committee and the IRS' National Taxpayer Advocate.

The inspector general recommended that the IRS expand its "Guide Me to a Service" tool to include a summary of the services available from the coalition's member companies and provide a direct link to the Spanish version of Free File. That version also should include a guidance tool as well as basic information about the program, the report stated.

In its response to the report, the IRS said it will consider implementing the recommendations, and will decide how to proceed by Jan. 15, 2007.