If there's no such thing as a free lunch, why is the IRS offering you one?

With April 15 seven months away, the Internal Revenue Service has been quietly laying the groundwork to allow 78 million taxpayers to file their 2002 returns online for free. Next year, 60% of the taxpaying public will pay nothing to e-file, thanks to an IRS partnership with a consortium of third-party tax preparation companies, such as H&R Block.

The IRS proposal, which was announced in July and will be up and running by year's end once the current plan is finalized, seems to benefit everyone. The government won't have to spend years and millions of dollars to set up a secure computer network for electronic transactions. Third-party tax preparers will be able to pitch services to a whole new stream of customers. And taxpayers will get their returns filed at no cost.

"E-filing is great. Consumers love it. It's faster, saves the government time and money, and taxpayers get refunds in half the time," said Tara Bradshaw, spokesperson for the Treasury Department, which is handing the proposal. "This makes sense."

But some consumer groups and IRS watchdogs are raising questions, many of which center on ceding such an important role as the middleman in the tax-filing process.

What Price Free?

Experts in the field of electronic tax preparation have questions about the IRS plan, starting with who, exactly, will be in the group of 78 million taxpayers who file free.

"How will the consortium offer these free services? There's no such thing as a free lunch, so how is this getting paid for?" asks Stephen Holding, a former IRS administrator who worked on the e-file program. "Is this just a customer acquisition strategy?"

On some levels, it is.

Under the terms of the proposal, the IRS will relinquish the right to determine who will file for free. Protections are in place for consumers in the proposal, notably a passage that says third-party providers cannot force customers to buy services in exchange for free filing.

"Even if someone agrees to be solicited for business, they can't make them pay for additional services or tie free filing to product purchases," said Bradshaw. "But it's up to the consortium to decide who gets to file for free. The IRS will look at all of the offers to make sure that it reaches the 60% figure."

If the past is any indication, then low-income taxpayers, military servicemen and senior citizens could be in line for free filing this spring. "But the short answer is, no one knows for sure," said Holding, who is also an assistant professor of information systems at the University of Maryland Baltimore County.

The Impossible E-Dream

Ultimately, the IRS will feed customers to third parties to meet an impossible demand placed on it by Congress during the height of the dot-com frenzy. Back in 1998, the IRS Restructuring and Reform Act dictated that 80% of all tax returns must be filed electronically by 2007 -- an optimistic ballpark figure that slipped into the final bill without debate.

"When I was with the IRS, I would talk to third-party providers about the goal, and they would fall out of their chairs laughing," said Holding. "People in the private sector realized that this was more than a stretch."

For its part, the IRS has publicly acknowledged that reaching this goal will be "difficult" but it also points out that the consumer approval rating for e-filing is much higher than for paper returns, and that growth has been steady, if not spectacular.

But there's no telling if this new proposal will help the IRS meet its 80% goal, in Holding's opinion, because consumers are reluctant to trust third parties on the Web. When the IRS first sent out postcards telling people they could file online through an intermediary, the response was mixed at best.

"When they found they had to go third party, they were furious. There's no other word to describe it," he said. "Even if it was free, they said they didn't want to use XYZ because they didn't trust them."

The Other Problems

And under the agreement, the IRS waives the right to compete with the consortium, creating a confusing scenario in which taxpayers can't electronically file their taxes with the IRS.

"Why can't a consumer file directly with the IRS instead of going to third parties?" asks Frank Torres, legislative council for the Consumer's Union. "Why not set up a program with libraries and schools?"

There are other questions, especially at the state level. More than 20 states already allow taxpayers to file for free, relying heavily on the standardized forms used at the national level.

"It's still unclear whether the providers in the consortium will be doing state returns at the same time," said Harley Duncan, executive director of the Federation of Tax Administrators, which represents state tax administrators. "There's no requirement for them to do so. If people flock to this and there's no state return, we'll lose out."

And consumer groups are upset that the IRS's agreement gives a tacit stamp of approval to refund anticipation loans, which charge exorbitant rates on short-term loans backed by tax returns. "You could call it loan-sharking," said Torres, who objects to the strange marriage of convenience between the government and business. "The IRS is telling people, 'Don't depend on us, go to these guys.' That's a problem."

The new IRS proposal raises many unanswered questions and could have unintended consequences, but it's worth stressing that no-cost e-filing will enable millions to quickly, accurately and easily pay the tax man in April.