Free tax filing isn’t always free: Extra costs add up for many self-filers

When is "free" tax filing not really free?

People wanting “free tax preparation” often find that state taxes, program upgrades, add-on charges, bank products and other fees can add up quickly.

In fact, many do-it-yourself filers could pay about the same to have a credentialed tax expert do them, and still get their refund in about the same time, and with the peace of mind of real professional guidance.

From January to April 15 of each year, Americans are bombarded with advertising for tax preparation software, online programs and stores.

The most common word in those commercials: Free. Of course, there are a few disclaimers on these commercials, far too many to list at the end, which even used car dealers seem to be able to do. Check out the websites of these “free file” tax advertisers, however, and that’s another story.

So, what does “Free” really mean to a taxpayer at using one of the most popular “do-it-yourself” tax programs? Well, that depends on what a taxpayer hopes or expects it to mean.

However, unless a person lives in one of the seven states with no income tax, rarely does “free” mean that a person can complete and e-file both their federal and state tax returns for free.

Those states are Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Tennessee and New Hampshire limit individual taxation to dividend and interest income. The other 41 states, DC and territories do have reporting requirements.

How it Started
Ten years ago, the IRS started the Free File system, which is a partnership between the agency and 15 private companies that make tax preparation software to offer free federal tax preparation and e-filing for many Americans with basic tax needs.

Since it is a voluntary partnership, the companies are not required to participate, and have quite a bit of leeway in designing their own pricing structures, as long as they meet a minimum threshold of preparing and e-filing free federal returns for most people in that income range, but with exceptions for some types of forms.

One of the goals behind the the IRS's Free File system was to spur electronic filing, which has certainly done. More than 75% of individuals now do so for their 1040 returns, either through a software program or a professional.

What “Free” Includes
As a result, qualifying for the free federal versions of these systems varies somewhat, but most of them are designed for preparing and filing very basic returns for Americans without a need for itemizing deductions or with business income and expenses. So, most of the systems do not include a Schedule C unless you upgrade, and many won’t provide even the Earned Income Tax Credit or Child Tax Credit, either.

Some other taxation issues that are almost never included in the free versions include multi-state incomes, capital gains taxes, extensive home-business office expenses, business asset depreciation, moderate investment income or those with household employees.

In no cases that I could find, do the free software programs include preparation of partnership, corporation, non-profit, trust or estate taxes. These definitely require an upgrade, but really, you should be using a true tax professional.

What “Free” Doesn’t Include
After use of the word free in their advertisements, probably the most emphasized feature has been customer support, access to tax professionals, guidance and other expert advice.

While one of the companies has been vocal in noting that their experts are made up of Certified Public Accountants (CPAs), Enrolled Agents (EAs) and Tax Attorneys, the fine print for those services (and similarly for the other programs) state that only live chat or email-based support is available with the free version. Want to talk on the phone? Upgrade.

Want to be able to automatically transfer last year’s data into the program? Upgrade. (Import last year’s tax form from PDF is sometimes available free.)