Series: The TurboTax Trap How the Tax Prep Industry Makes You Pay

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More than 14 million taxpayers paid for tax prep software last year that they could have gotten for free, according to a scathing audit released Wednesday by the Treasury Inspector General for Tax Administration. That amounts to roughly a billion dollars in revenue for TurboTax maker Intuit, H&R Block and other tax software companies, according to a ProPublica analysis of tax prep fees.

The audit, which was launched following ProPublica’s reporting last year, explores why so few taxpayers use the Free File program, a public-private partnership between the IRS and companies such as Intuit and H&R Block. Among the reasons, the audit found: the confusing design and complexity of the program and persistently lax oversight by the IRS.

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The program has been the industry’s tactic to beat back any possibility of the IRS creating its own free tax filing options. It makes free tax prep software available to most Americans, but Intuit and other companies have also found ways to direct people away from Free File and instead to commercial “free” editions, which are not always free.

“The process to participate in the Free File Program is fraught with complexity and confusion. IRS management seems unaware of the complexity and confusion taxpayers face,” the audit states.

In December, responding to ProPublica’s coverage and criticism from multiple elected officials, the IRS reformed the Free File program. Now companies are barred from hiding their free products from search engines such as Google, and a years-old prohibition on the IRS creating its own online filing system has been scrapped. It remains to be seen whether the IRS will, in fact, create such a free system.

In the tax agency’s response to the new report, IRS official Ken Corbin pointed to the reforms made to the program and an outside review commissioned by the IRS that was friendlier to agency management. “The testing reflected in the Treasury Inspector General for Tax Administration’s report does not duplicate the extensive research performed and reported by The MITRE Corporation. We believe both reports should be considered by outside readers to obtain a fully balanced and objective assessment of the Free File program, overall,” Corbin wrote.

In a statement, an Intuit spokesman said the company “consistently and publicly supported recommendations and efforts to strengthen the [Free File] program as part of our commitment to free tax preparation and our mission to empower individual taxpayers to manage their finances and receive every dollar they earned and deserve.” He added that “the majority of eligible tax filers using DIY software filed for absolutely free through the Free File Program or using commercial products.”

Around 104 million taxpayers were eligible for Free File last year, according to the audit. Of those, just 2.4% actually used the free government program.

Of the remaining 101.5 million, 67 million did not use tax software (most going to bricks-and-mortar tax prep services). The remaining 34.5 million used software to do their taxes, and of those, 14 million paid for tax prep they could have received for free. To arrive at that number, the inspector general conducted a survey it deemed statistically valid of 200 taxpayers who’d qualified for Free File but used a commercial online product.

Intuit says in public filings that it makes an average of $62 for each return, but that figure incorporates many people who file for free, so the average revenue for each paying customer is significantly higher. The company’s TurboTax unit generated $1.6 billion in operating income in the most recently reported fiscal year.

More eligible tax filers finding Free File could represent a threat to the company’s profits, according to a December note to clients from J.P. Morgan analyst Sterling Auty, who covers Intuit. “We want to acknowledge the risk that we could see some portion of that population move to free once they realize what is available to them,” he wrote.

The audit also found that since many taxpayers don’t know about the IRS’ Free File website, they simply use a search engine like Google. That often leads them to commercial sites for products such as TurboTax or H&R Block online.

A graphic from the inspector general shows the complexity of using Free File. (Treasury Inspector General for Tax Administration)

The report urges the IRS to take a number of steps to address the Free File program’s shortcomings. The IRS should boost its oversight to make sure the companies are following the program’s rules, add a way for taxpayers to submit complaints about the program and more carefully track the program’s performance, the report said. The IRS generally agreed with the recommendations.

Some recommendations seem unlikely to materialize soon, given the limits of IRS funding. The inspector general, for instance, urged the IRS to “develop a comprehensive outreach and advertising plan” for the program. But the IRS hasn’t spent any money to advertise the program since 2014 for an obvious reason: The agency’s been gutted by budget cuts.

In response to the suggestion, IRS management told the inspector general that the agency would “begin a dialogue” with the online tax prep companies “to identify opportunities to increase awareness about the Program,” the report says. It adds, “However, no formalized strategy was developed outlining specific actions to be taken.”

In a statement, Sen. Ron Wyden, D-Ore., the ranking minority member on the Senate Finance Committee and a supporter of making tax filing cheaper and easier, said the inspector general’s findings confirm ProPublica’s reporting that “the Free File program is a mess.” He added, however, that “recent IRS reforms to the program do right by taxpayers. … The IRS must be vigilant in enforcing these reforms, and Congress must provide the IRS the resources to develop a free public service.”