The Free File Program: Low Participation Rates and De-indexing by FFI Members, Schemes and Mind Maps of Marketing

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New York State

Department of Financial Services

Report on Investigation of Free Tax Preparation and Filing Services

July 2020

I. Summary

The New York State Department of Financial Services (the “Department”) was created in 2011 to accomplish, in part, the following goals: (1) ensure the safety and soundness of New York’s banking, insurance and financial services industries, (2) ensure prudent conduct of providers of financial products or services, and (3) promote the reduction and elimination of unethical conduct by and with respect to banking, insurance, and other financial service institutions. Pursuant to this mandate, in May 2019, the Department undertook an investigation into the low participation rates in a program created by the Internal Revenue Service (“IRS”) intended to aid disadvantaged taxpayers. More specifically, the Department reviewed the IRS’s Free File Program (“Free File Program” or “Program”), which assists disadvantaged taxpayers in filing tax returns at no cost, and the circumstances that have led to unacceptably low participation rates in that initiative. The Department initiated this investigation following a series of articles published about the Program by a media outlet, including one article in April 2019 that claimed five tax preparers who participated in the Program had hid their landing pages for the Program from search engine results, a practice known as “deindexing” that interfered with taxpayers’ ability to utilize the Program. In May of 2019, the Department issued subpoenas to the five tax preparers who were the subject of the above-stated articles. Since then, the Department has conducted an extensive investigation that included the collection and review of thousands of documents, and the questioning of witnesses under oath. After careful consideration of documents, testimony, and other submissions, the Department concludes that Intuit, Inc. (“Intuit”), H&R Block, Inc. (“H&R Block”), TaxHawk Inc.

that FFI’s members, including Intuit and H&R Block, will offer free tax preparation and filing services to disadvantaged taxpayers in exchange for the IRS agreeing not to develop its own free tax preparation and filing service.^1 The MOU makes clear that the agreement aims to “set forth parameters to which industry members of the [FFI] would offer online tax preparation and filing services to taxpayers least able to afford e-filing tax returns at no cost to such taxpayers.” In 2019, approximately 104 million U.S. taxpayers were eligible to file their taxes for free using the Free File Program. However, actual usage of the Free File Program is startlingly low. In each of the last three years, fewer than 2.5 million taxpayers filed their taxes using the Free File Program. In other words, less than 3% of eligible filers took advantage of the Free File Program in 2019. The Treasury Inspector General for Tax Administration (“TIGTA”) estimates that more than 34.5 million eligible taxpayers used the FFI Members’ commercial software to file their Tax Year 2018 return (and of those, 20.4 million filed for free), and the remaining 67 million taxpayers filed by some other means.

In the same year, nearly 292,000 New York State taxpayers who were eligible to file a free tax return online under the Free File Program paid Intuit for online tax preparation and filing services, while nearly 74,000 other New York State taxpayers who were eligible for free tax

(^1) The Addendum to the Eighth MOU, entered into in December 2019, struck from the Eighth MOU the federal government’s pledge not to enter the tax return software and e-file services marketplace.

services under the Free File Program paid H&R Block for online tax preparation and filing services. As further discussed below, actions undertaken by the same tax preparer companies designated by the IRS to participate in the Free File Program also worked to draw consumers away from the Free File Program. In addition, without question, the low participation rate in the Program was due in part to the IRS, which was criticized by its internal watchdog for failing to allocate sufficient resources to increase public awareness of the Free File Program.

III. FFI Members Worked to Steer Taxpayers Away from the Free File Program

Several FFI Members -- tax preparer companies that agreed to participate in the Free File Program -- worked to draw consumers away from the no-cost option. These tax preparer companies did so by employing a two-pronged approach that: (1) the FFI Members created and marketed products as “free” in order to lure customers away from the Free File Program while upselling those same customers into more costly products; (2) FFI Members worked to remove website pages from internet search engine results, a process also known as “de-indexing,” thereby concealing references to the Free File Program in search results. A. Monetizing “Free” Even though FFI Members agreed in 2002 to offer free tax preparation and filing services pursuant to the Free Online Electronic Tax Filing Agreement signed with the IRS, they were immediately concerned about the impact of the Free File Program on their bottom lines. During a 2007 investor call, Intuit’s CEO acknowledged that several years earlier, Intuit’s “big question was the Free File Alliance and how that would negatively impact TurboTax growth.” Within a few

products” and that Intuit “continue[s] to expand the [free] category by getting new customers into the category and in looking for ways to monetize them.” Also in April 2008, in response to a question about how the company has been able to retain revenue despite the shift to web-based and no-cost tax filings, Intuit’s CEOexplained that “it comes down to continuing to understand how to bring customers in and then create opportunities that help solve additional problems that they are willing to pay for.”

• In August 2008, Intuit advised investors that it would continue to grow its share ofthe consumer tax market “using our free offer.”
• In February 2009, Intuit stated “we have the means to monetize customer relationships over time and generate profits, even if we originally acquire the customers with a free product. We’re being aggressive in our demand generation,promotional offers, and the use of free products to bring new users into the franchise.”
• In May 2009, Intuit advised that “our free offering performed as expected and brought in lots of new, profitable customers.” It further stated that “TurboTax Freeremains an extremely effective way to bring new customers into our tax franchise. . .”
• In 2010, Intuit stated that “[w]e’re seeing a nice increase in revenue per customer, driven by continued conversion from free to paid, and continued improvements in product mix.”
• In 2011, Intuit explained that “[o]ur #1 priority is to get more customers into the franchise, because we’ve shown we can increase the revenue per customer 5x over a 5-year period. So bar none, the thing we wake up every morning thinking about is grow the category, convert nonconsumption, get people in here and then find away to increase revenue per customer over time.”
• In 2011, Intuit further explained that “we start with a free offering, and then we add additional value, and we price for that value. And in the marketplace we've been able to demonstrate that we can get customers in on free and then convert them to a paid product, or we can actually find other solutions for them that they’re willingto come in and pay for. So the elasticity really comes down to how much value the customer sees in the product itself. And we’ve been able to compete very effectively with low-priced alternatives in the online space for over a half dozen years.”
• In 2013, Intuit described the free-to-pay model as “the best customer acquisition strategy we’ve had.”
• Also in 2015, Intuit explained that “our track record is we can bring people in on free. We can monetize many of them in the same season. But we also tend to

monetize more of them the following season and that just continues to be a formula that pays off.” Like Intuit, H&R Block also employed a free product to attract customers. In or around 2017, H&R Block started to focus its overall marketing strategy on its existing commercial free product, which at the time was known as “H&R Block More Zero.” In an internal document, H&R Block explained: “Free is now the new norm and in order to compete, we recognize that we need to have a product offering that appealed to all segment of tax filers in the DIY [do it yourself] category.... It's also important to note that while we are expanding our free offering, there are still opportunities to monetize within the free product.” In an internal document, H&R Block described its ability to monetize the free product “through selling additional services within the product flow as well as from filers graduating to more complex returns and/or products when they return.” In 2017, one-third of H&R Block’s “free” clients upgraded to a paid product. FFI Members’ no-cost products directly competed with the Free File Program. These competing product offerings, in turn, led to confusion among taxpayers. In sum, taxpayers eligible for the Free File Program nonetheless paid for tax preparation services. Another concern is that taxpayers who would otherwise qualify for the Free File Program, or no-cost services could be manipulated into paying for unnecessary upgrades and upsells. While TIGTA estimates that, in 2019, 20.4 million taxpayers eligible for the Free File Program filed their taxes for free using a commercial free product, TIGTA estimates that another 14.1 million taxpayers who were eligible for the Program nevertheless paid for online tax preparation services. B. De-Indexing the Free File Landing Pages One explanation for underutilization of the Free File Program by eligible taxpayers is lack of public awareness of the no-cost option. In 2019, Intuit spent approximately $117,000 on paid search advertising to promote the Free File Program when a taxpayer searched for “TurboTax

emphasizing that de-indexing did not violate their agreement with the IRS. An Intuit employee testified before the Department that Intuit had decided to de-index the Free File Program landing page to avoid confusing consumers when it changed the name of the Free File Program product from “Freedom” to “Free File.” H&R Block explained that it de-indexed H&R Block’s landing page for the Free File Program to fix an erroneous feedback loop that caused people who landed on that page to always be directed back to that page after visiting it once. Intuit, H&R Block, TaxHawk, and TaxSlayer insisted that de-indexing did not violate the MOU. Drake went further, arguing that the practice of de-indexing was done to ensure compliance with the MOU. The relevant provision of the MOU specifies that “the IRS will provide taxpayers with links to [Free File services] offered by [FFI] participants through a web page, which is hosted at irs.gov with links from www.usa.gov.” In essence, the companies argued that the underlying bargain they struck with the IRS was that they, the tax preparers, would provide free services, while the IRS carried the burden of marketing the Free File Program. The companies also pointed out that de- indexing did not render the landing pages wholly inaccessible, even if they were hidden from search engine results. In addition, one company claimed that it had increased spending on paid advertisements for the Free File Program in 2019. However, our review of documents indicates that, for at least one FFI Member, a significant factor in choosing to de-index the company’s Free File Program landing page was to protect revenue. Prior to 2018, Intuit named its Free File Program product “TurboTax Freedom” or “TurboTax All Free.” In 2018, Intuit was deliberating whether to change the name of that product to “TurboTax Free File” to generate political goodwill with FFI and the IRS, in response to criticism that the TurboTax’s offering under the Free File Program (then named Freedom Edition) and its commercial no-cost offering (TurboTax Free Edition) were confusingly named. However,

Intuit immediately recognized that from a search engine optimization perspective the newly named Free File Program offering would compete more directly with the commercial no-cost product because both have the word “free” in the name. Intuit calculated that there was a 50% chance that Google would rank the Free File Program offering (TurboTax Free File) above TurboTax Free Edition in organic search results, which are the free listings on Google. If that happened, Intuit estimated that it would suffer a revenue loss of approximately $3.9 million. Intuit went ahead with changing the name of the Free File Program offering to “TurboTax Free File,” but to avoid that product’s landing page being at the top of organic search results, Intuit de-indexed the landing page for its Free File Program offering. In sworn testimony before the Department, one Intuit employee claimed the reason for the deindexing was to avoid a negative consumer experience for consumers who were specifically using search terms that included the word “free.” Specifically, she testified that: We were concerned because the Turbo Tax Free Edition product[] is traditionally ranked first. What we didn’t want to happen is for customers looking for our commercial products inadvertently choose the Free File product and find out that they don’t qualify. When they don’t qualify for the Free File Program, it’s a verynegative customer experience. After a media outlet published a story accusing the five FFI Members of de-indexing their Free File Program landing pages in order to steer consumers to the FFI Members’ proprietary products, in December 2019, FFI Members and the IRS amended the MOU to prohibit de-indexing of FFI Members’ landing pages for the Free File Program. In addition, TIGTA conducted an audit of the Free File Program. In its written report issued in 2020, TIGTA found that the de-indexing of the companies’ landing pages for the Free File Program had “contravene[d] the intent of the

https://turbotax.intuit.com/personal-taxes/online/, and then instructed to “[t]ell us about you – we’ll recommend the right tax solution.”

As of June 30, 2020, nine of the 12 prompts on this page direct a taxpayer -- who had just clicked “File for $0” to get to this page -- to choose a paid product. For example, if a taxpayer clicks on the first prompt, “I want to maximize deductions and credits,” Intuit recommends TurboTax Deluxe, which at that time costed $60 for preparing a federal tax return, and additional fees for preparation of a state income tax return. In 2019, an internal Intuit review found that customers were being upsold when they sought to qualify for no-cost services. Even worse, the review found that some of these taxpayers were being upgraded into costlier products without realizing they were being upgraded. Although the initial purpose of the review was to determine why fewer taxpayers were upgrading to TurboTax Live than originally projected, an Intuit employee complained that customer service agents were recommending unnecessary upgrades to taxpayers, and that Intuit’s “Free, Free, Free” advertising campaign was leading taxpayers to assume they would be filing their taxes for free. These findings

were distilled in a presentation to other Intuit employees, including quality assurance analysts, and included the following slide:

Customer complaints produced by Intuit provide examples of the confusion and obstacles taxpayers encounter when seeking to file a no-cost tax return on Intuit’s commercial website. For example, when one customer called Intuit’s TurboTax customer support hotline, he complained that the website “ask[ed] me how I want to pay for it. I thought this service was free.” In response, Intuit’s customer support representative stated “it starts out free, but depending on the situation it may upgrade.” The conversation continued as follows: Intuit: [W]hile you’re working on the return, a lot of times it will ask about TurboTax Live. So, if you’re not careful and you select that you want to do that, it will upgrade you to the Live version where you can talk to a CPA or [Enrolled Agent], which I am not. I’m only tax support which is available to any customer. So, the only way to get it off at this point is um, you would have to clear and start over and then go back through it and just make sure you just don’t add the upgrade to Live during your...

The IRS has provided insufficient oversight of the Program since its inception. For the first 15 years of the Free File Program, for example, the IRS declined to take a position on whether FFI Member companies should index Free File websites such that their Free File Program offerings would appear in online search engine results, according to the June 2020 report of the Staff of the Permanent Subcommittee on Investigations, to the Senate Committee on Homeland Security and Governmental Affairs (the “PSI Report”), concerning IRS oversight of the Free File Program. In 2007, TIGTA noted that the IRS’s oversight of FFI Members was not fully documented. In 2018, the Internal Revenue Service Advisory Council, an external advisory board that provides an annual report to the IRS Commissioner, concluded that “[t]he IRS’s deficient oversight and performance standards for the Free File program put vulnerable taxpayers at risk,” and thereby raised difficulties in ensuring FFI Members’ compliance with the MOU. In 2020, TIGTA likewise concluded that the IRS did not provide sufficient oversight to ensure the Program was operating as intended. TIGTA’s 2020 Report identified several MOU requirements that the IRS failed to test. For example, the IRS did not test to determine whether each FFI Member was offering common IRS forms and schedules in connection with the Program. In its 2020 report TIGTA also noted that without proper oversight, the IRS was unable to identify other potential problems with the Free File Program. The PSI Report likewise pointed out that the IRS has conducted insufficient oversight of the Free File Program in the past. In addition to lacking sufficient oversight, the Free File Program has been chronically underfunded and underpromoted. In 2007, TIGTA recommended and the IRS agreed to develop a marketing plan for the Program. According to TIGTA’s 2020 report, from fiscal year 2009 to fiscal year 2014, the IRS spent between $750,000 and $1 million annually to promote the Program. These amounts stand in stark contrast to the nearly $200 million tax preparer companies, including FFI

Members, have spent on television advertising in a single year. Over the course of the last decade, federal funding for the Free File Program ranged from insufficient to non-existent: no federal funds have been allocated for the IRS to promote the Free File Program since the end of fiscal year

2014. Without funding, the IRS has not run advertisements concerning the Free File Program in media outlets -- including newspapers, radio and television -- since 2014.

VI. Conclusion In sum, the Department’s investigation found that the Free File Program does not function as intended. The Program, at its core, sought to rely on commercial tax preparation companies to provide free services to more than 100 million disadvantaged taxpayers in a transparent manner. Instead of doing so, the tax preparation companies engaged in unfair and abusive practices that undermined the Program by creating and marketing their own “free” products that directly competed with the Program, with the purpose of upselling customers to pay for their services. In addition, five tax preparation companies worked to remove Free File Program webpages from internet search engine results. In doing so, these practices led millions of consumers to needlessly pay for tax services they should have received at no charge. In addition, the IRS’s failure to educate consumers about the Free File Program left in the cold those who most needed these services. In acknowledging the system is broken, the IRS should allocate resources to adequately market the Free File Program. In the meantime, eligible taxpayers should take advantage of the Free File Program, by visiting https://www.irs.gov/filing/free-file-do-your-federal-taxes-for-free. Taxpayers can use the IRS’s lookup tool to determine which Free File product is right for them: https://apps.irs.gov/app/freeFile/jsp/wizard.jsp. Information concerning free filing options for New York state taxes is available at https://www.tax.ny.gov/pit/efile/.