Tax Firms Battle State Over E-Filing Services

A battle over who should provide electronic tax-filing services is brewing in California, where the state’s fledgling Internet-based tax system is raising the hackles of companies that sell tax-preparation software.

Intuit Corp., the maker of TurboTax and one of a small number of software firms now offering free e-filing of state tax returns in California, already has said that it would yank its free filing option if Sacramento continues to provide a competing product. Several other software firms are planning to fight what they consider to be the state’s encroachment on their business.

Online filing is seen as advantageous to taxpayers because it’s quick compared with filling out forms by hand and less expensive than hiring a professional preparer.

“We feel that California should not be in a competitive posture with the software industry,” said Atilla Taluy, president of FileYourTaxes.com in Ventura. “If the state remains in this business, it does not appear to be a very encouraging partnership between the public sector and the private sector.”

The Franchise Tax Board, which oversees the state’s tax system, will hold a hearing Dec. 2 on the issue, at which state officials and representatives of tax-software companies are set to square off.

The Franchise Tax Board is expected to decide shortly after that meeting whether to let state officials continue their free e-filing program and proceed with plans to develop an even wider range of online tax-filing products, or whether the state’s year-long experiment with free electronic tax filing should come to an end.

At the heart of the controversy is the relatively recent phenomenon of free online filing -- both on a state and national level. Last year, the Internal Revenue Service launched a public-private partnership with about two dozen tax-software firms, essentially letting them advertise through the IRS’ Web site in exchange for providing free e-filing to at least a segment of the nation’s taxpayers.

About 2.8 million federal tax returns were filed electronically last year as a result of the partnership, said Michael F. Cavanagh, manager of the Free File Alliance in Alexandria, Va., which represents tax-software firms.

However, there was a catch. In exchange for offering free e-filing to some taxpayers, the Free File Alliance demanded that the IRS not provide its own free service to all taxpayers. “The cornerstone of the agreement was that there would not be a competing federal product,” Cavanagh said.

Similar arrangements have been worked out between private software firms and several state taxing authorities.

However, California broke with the federal model last year by offering its own direct filing option for those who file the simplest state tax form, the 540-2EZ. And just two days before the April 15, 2003, tax filing deadline, the state came out with a second free e-filing option -- a 540A form, which can be used by many middle-income families and which the Franchise Tax Board dubbed Net File.

The state was developing a third product that could be used by almost any California resident to file a state tax return electronically. But state Controller Steve Westly put the project on hold while the Franchise Tax Board studied both the cost to the state of providing the service and the objections of private software firms.

“We are looking at the top level of what is appropriate for the state to provide,” Westly said. “I have challenged both sides to come back with further information.”

About 38,000 of the state’s 14 million taxpayers used the Franchise Tax Board’s direct filing system in 2003, said board spokeswoman Denise Azimi.

Compared with the slick, interactive products offered by private firms, the state’s system is highly unsophisticated -- essentially an online version of paper tax forms. Still, by providing it, the state can reach people who either because of privacy concerns or cost are reluctant to buy tax-preparation software.

“We felt it was the right thing to do,” Azimi said. “It’s a government requirement that you file a tax return, and a lot of consumers who call us don’t think it’s fair that they should have to pay to file electronically.”

Tax officials say that nearly 90% of the nation’s taxpayers qualify for free filing on the federal side, but fewer options exist when it comes to state returns.

For example, H&R; Block offers free federal filing online for low-income consumers, but it does not offer free state returns. The preparation of most state returns costs $14.95, says company spokesman Tom Linafelt.

Many other companies, including TaxSlayer, Tax Brain and US File Direct, offer free state returns only to those who pay to have a federal return prepared. A few others offer free state returns only to those who use the 540-2EZ.

Free filing deals for the 2004 tax season haven’t yet been completed. Last year, nine companies provided either free or discounted services to California residents.

Intuit, the national leader with its TurboTax-for-the-Web product, provided the most expansive offer -- free filing to anyone with income under $27,000 or who qualified for the Earned Income Tax Credit, a program for the working poor. About 90,000 Californians filed state returns for free in 2003 through TurboTax, according to Intuit spokeswoman Julie Miller.

Depending on what happens at next month’s Franchise Tax Board hearing, however, that offer may well be rescinded. “We will continue to provide federal returns as we have,” Miller said, “but we will only provide state returns free in those states that create an alliance like the federal partnership.”

In other words, for Intuit to stay in, the Franchise Tax Board needs to get out.

For his part, Westly is hopeful of reaching some kind of resolution. “My goal is to get both sides to work together,” he said, because the bottom line is “to make it as easy as possible for Californians to file their taxes online at the lowest possible cost.”