Free File code worries tax pros

IRS Free File Web site

The Internal Revenue Service's Free File program has become the focus of a digital-privacy dispute between the IRS and tax-preparation companies that take part in the Free File program, a free Internet service used mostly by low-income taxpayers last year.

Beginning this tax-filing season, the tax agency is asking the participating companies, known as the Free File Alliance, to add an electronic identification code to the returns of taxpayers who use the free Internet service. The IRS is still negotiating with the tax-preparation companies, some of whom have refused to comply. Although IRS officials say privacy concerns are unfounded, a number of firms have publicly criticized the IRS request, citing privacy concerns.

Officials at tax-software maker Intuit Inc., one of 17 companies in the Free File program, have said they will refuse to identify tax returns submitted electronically through its Free File service. Last year, Intuit prepared 1.2 million of the 2.8 million returns filed through the IRS program, said Julie Miller, a spokeswoman for Intuit.

"The Free File Alliance is a public-service initiative that is focused on helping the working poor, lower income and underserved taxpayer," Miller said. "Specifically tagging or profiling these returns separate and apart from all other tax returns we believe is an invasion of privacy."

Officials at TaxBrain, which last year had offered free electronic filing to older taxpayers under the same program, have issued a statement saying they will not participate in 2004 because of the policy change that they say would "adversely compromise the privacy of taxpayers." TaxBrain is an online division and Internet business for Petz Enterprises Inc.

H&R Block Inc., the well-known tax preparation company, will remain in the program and comply with the IRS request, company officials said. But H&R Block executives told USA Today that they, too, had privacy concerns about identifying Free File returns for the IRS.

IRS officials say the additional code would help the agency in marketing the Free File service to more taxpayers and would in no way flag those returns for an audit, as critics have suggested. The IRS already uses such codes, on paper and electronically filed returns, to help agency officials analyze filing trends and pinpoint errors in some of the tax software packages, said Nancy Mathis, an IRS spokeswoman. The new request, she said, "is consistent with our current policy and past practices."

"We have processed more than 320 million tax returns since the inception of electronic filing and have never once compromised the privacy of a taxpayer," Mathis said.

IRS officials have posted a notice on the agency's Web site for the Free File program asking taxpayers to check back later in the month to view a new list of companies that are participating in the program.

In 2001, Office of Management and Budget officials asked the IRS to work with the tax software industry to develop a program of free online tax preparation and electronic filing as a way to induce more taxpayers to file their returns electronically. As part of the deal, the IRS agreed not to develop a free service that would compete with the paid services offered by tax software companies.

The IRS authorized 17 tax preparation companies to offer their software and services free to some taxpayers through the Free File program. Each company could decide who would be eligible for the free service. Other taxpayers would still have to pay the company if they used its software and services to prepare. But the deal, by any measure, was huge: 78 million, or 60 percent of all taxpayers who file individual returns, would be eligible for the free services.

Tax officials have much riding on electronic filing. A deadline set by Congress hangs over the agency. Legislators have told the IRS they want 80 percent of the nation's taxpayers to be filing their returns electronically by 2007.