NerdWallet: Taxpayers wasted as much as $13 billion on filing federal returns, when they could have filed free
This article is reprinted by permission from NerdWallet.
It’s a worthwhile aim: Make the annual filing of federal income taxes both easier and free for millions of Americans. But although those have been explicit goals of the IRS Free File program since its inception nearly 20 years ago, the revenue service and an alliance of several tax software companies fall considerably short, and a majority of taxpayers, including those with the lowest incomes, are paying the price.
Though 70% of taxpayers qualify for Free File, less than 3% actually use the service. This shortfall of some 87 million taxpayers, on average, could put as much as $13 billion in the pockets of tax prep companies and professionals each year, according to analysis of IRS data and a NerdWallet survey conducted online by The Harris Poll.
How Free File works (ideally)
In 2002, the IRS joined forces with a group of tax software providers, known as the Free File Alliance, to provide free filing services to federal taxpayers meeting certain income qualifications. Each year, 70% of all taxpayers who earn the least qualify to use Free File software. The income cap used to reach this 70% goal is reevaluated annually by the IRS. In 2022, those with adjusted gross incomes of $73,000 or less qualify.
While $73,000 of income may make you fairly comfortably middle class, in some areas of the country, roughly half of those with an adjusted gross income below $75,000 actually had an income of less than $30,000 in the 2020 filing year.
Taking advantage of Free File requires taxpayers to navigate to the IRS website and choose a software company from the agency’s portal. There are currently eight providers of the Free File service, including lesser-known software companies like 1040Now and TaxSlayer. Bigger-name companies such as TurboTax and H&R Block
have left the Free File Alliance over the past two years. The eight remaining may control how many returns they do for free by having additional limits such as age, state of residence and more restrictive income caps. Taxpayers are able to view these restrictions and choose a provider that fits their needs before navigating from IRS.gov using a direct link to the partner’s Free File page, where they can begin their income tax return.
The cost of not filing for free
Assuming a typical $150-per-taxpayer filing cost and reviewing a decade’s worth of IRS data, we estimate Americans could be overpaying to the tune of up to $13 billion each year. Even a more conservative estimate — $40 per taxpayer, on average — puts the tab at $3.5 billion.
An analysis of 10 years of IRS data indicates 2.4% of taxpayers file their federal return for free each year, on average, using either Free File software or paper forms. That means over the past decade, roughly 87 million taxpayers each year have failed to file for free, despite being eligible.
In 2020 alone, among 148 million individual tax returns filed, just 4.2 million were filed for free, a shortfall of 99.5 million from the 70% benchmark. Because the number of federal filers has increased each year over the past decade, so has the size of this shortfall.
Americans who paid to file federal tax returns in 2021 typically spent $150, according to a recent NerdWallet survey conducted online by The Harris Poll among 1,025 federal filers who paid to file 2021 taxes (referred to as American filers). Half of American filers paid less and half paid more.
Assuming those who failed to Free File paid roughly the same as other paying filers, that’s $13 billion in unnecessary spending.
How much someone pays to file their tax return depends on a variety of factors, including the complexity of the return, the software company they use and whether they choose to hire a professional. Even those who plan to use a tax company’s free option may be convinced to upgrade to paid versions when it’s not entirely necessary, according to a years-long investigative series from ProPublica. Some of the least-expensive software options hover around $40. Even at that rate, those who could’ve used Free File are spending $3.5 billion unnecessarily.
And remember: This group includes the lowest-earning taxpayers in the country.
Taxpayers likely don’t know about Free File options
Offering a product or service doesn’t guarantee its use — people have to know it’s available. Taxpayers who knew they could file their federal return for free likely would. The volume of those failing to take advantage of the Free File service indicates many may simply be unaware.
A 2020 audit of the Free File program by the Treasury Inspector General for Tax Administration found about 30% of taxpayers who paid to file didn’t know about the program or how to access it. When confronted with this finding, the IRS responded that it advertises the service and rules governing it through its website, social media and press releases, materials the average taxpayer — unless they fancy themselves an income tax wonk or IRS fan — isn’t likely to encounter.
And knowledge of the program isn’t enough — taxpayers must also understand the requirement that they access these filing options through the IRS website. Navigating directly to a Free File Alliance member page doesn’t ensure taxpayers are encountering the Free File option, and they may instead be seeing a software company’s free version not governed by the same rules of the agreement with the IRS.
The biggest tax software providers specialize in murk
If taxpayers take to Google
to find “free file” results, they’re met first with three to four sponsored ads, each for free versions of tax software not governed by the Free File Alliance rules. A small “Ad” designation differentiates the results. Only after scrolling past these do people find an IRS entry point.
This potential trap was one of many called out in a 2019-20 investigative series from nonprofit newsroom ProPublica that identified how popular tax software companies actively worked against making tax preparation simpler and more affordable for taxpayers. These companies would offer their free services but use clever marketing to convince users to upgrade for a fee, according to the series.
These companies also commonly increase their prices as the tax deadline draws near, penalizing taxpayers who don’t file right away.
In addition to muddying the waters about what qualified as Free File versus filing for free, at least one of the tax software giants was found to be withholding its true Free File landing pages from Google search results.
This series and the attention it garnered led to increased scrutiny and ultimately tightened standards in the Free File Alliance agreement.
In 2020, H&R Block left the Free File Alliance. TurboTax, owned by Intuit, followed suit in 2021.
Also see: Did you change jobs in 2021, start investing, or get sick? It could affect your taxes.
What taxpayers need to know in 2022 and beyond
Know if you qualify for Free File
Your 2021 adjusted gross income must be $73,000 or less to qualify for IRS Free File this year. You can begin your return with one of the Free File Alliance companies or estimate your AGI yourself, if you’re uncertain whether you meet the income qualifications.
Access Free File only through the IRS website
On the official IRS website, browse all eight providers or use an IRS tool to choose the Free File software company that best fits your needs. If you use a search engine to find “free file,” you run the risk of landing on a page not beholden to the IRS-Free File Alliance rules.
Know what to expect when you file your state return
Twenty-two states and Washington, D.C., offer their own Free File program, according to the IRS. But fees in other states vary widely. The tax software company you choose should be able to walk you through the costs and specifics, given your state(s) of residence. You can also visit the website of your state’s Department of Revenue to check cost specifics ahead of time so you’re not caught off guard.
Don’t miss: ‘People have a lot of options. They have Amazon. They have Walmart:’ IRS chief says his agency competes with big-box stores for staff
If you don’t qualify for Free File, tread cautiously
There are many tax software companies offering filing help for a fee, and these fees vary widely. Research your options so you know what to expect for the price you’re paying and the services you really need.
Know where to turn for help
Tax preparation software generally holds your hand through the filing process, but questions may arise. Many tax prep companies have online chat services and telephone assistance to answer questions as you go, but they may come at an additional price.
Also see: Did you benefit from student-loan debt relief? Know the tax consequences
The IRS provides answers to some frequently asked questions, opens Taxpayer Assistance Centers in more populous areas during tax season, and provides tax preparation services to some populations including adults 60 and older and people living with disabilities, as well as people with low incomes or limited English. The agency can also be reached at 800-829-1040 for simple tax help.
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Elizabeth Renter writes for NerdWallet. Email: email@example.com. Twitter: @elizabethrenter.