	Background

Individual federal taxpayers have several options for preparing and filing  their returns as shown in figure 1. As part of the  Free File agreement, IRS agreed not to compete with the Alliance  members by providing free, on-line tax return preparation and filing  services to taxpayers on its Web site. Some taxpayers electronically prepare their returns but they choose to  print and mail the tax return to IRS. MITS has the information technology (IT) and programming staff that  develops and maintains IRS’s electronic filing systems, including hardware  and software. Some states restricted eligibility by  income, residency requirements, or number of itemized deductions. State I-file Systems Reduced Paper Filing, but the Magnitude of the Benefits Was Limited by Low Usage

According to officials in five of the eight states we profiled, state I-file  systems generated benefits (before subtracting the costs of system  development and operation) by increasing e-filing and reducing paper  filing. However, the benefits were limited by the low usage. While Pennsylvania had 20 percent of eligible  taxpayers using I-file, GAO is interpreting this as a low usage rate since the  state instituted the system in 2000. The number of taxpayers converted from paper filing to electronic filing  due to state I-file systems is relatively modest. Taxpayers who were charged electronic filing fees and convert  to I-file would save. Available data on total I-file costs show costs are a small percentage of  state tax agencies’ budgets. For example, California spent just over  $700,000 to develop and operate CalFile from 2003 to 2005—less than 0.1  percent of the tax agency’s annual budget. Several factors contributed to keeping I-file costs relatively modest. Whether States Realize Benefits Greater Than Costs from Their I-file Systems Is Unclear

In all states profiled, whether benefits are greater than costs is unclear for  two reasons. As previously noted (1) data on benefits and costs was  incomplete and (2) based on available data, both benefits and costs were  modest. Achieving a Net Cost Savings for IRS Depends on the Cost of Developing the System and the Number of Paper Filers Converted

Providing federal taxpayers with an I-file system would be a new service  for which IRS would incur new costs. To  develop the new service, IRS would have to (1) create or procure return  preparation software for IRS’s Web site and (2) extend direct e-filing to  individuals, in which the return would be routed into the current stream of  electronically filed returns coming in from EROs. Transactional Web  sites require more security and other features not necessary for an  informational Web site. Other factors that could cause IRS’s fixed costs to differ from the states’  fixed costs include the relative complexity of the federal tax system, the  types of taxpayers who are eligible, and the features of the I-file system,  such as memory. Features such as save and return and auto- populating can require additional memory and potentially increase costs. IRS’s variable costs for an I-file system could also be higher than the  states’. The key to IRS achieving a net cost savings  depends on the number of individuals converted from paper to electronic  filing and the savings per return (estimated to be $2.36 per return by IRS). Because v-coders prepare their return on a computer, they  are presumably more comfortable with computers and may be more  willing to try I-file than taxpayers who did not use a computer to prepare  their returns. The report is  available at no charge on GAO’s Web site at http://www.gao.gov. Reported benefits to the agency:    Fewer processing errors   Increase in taxpayers paying via e-pay    Faster payment processing    Cost savings per I-filed return    Reported benefits to the taxpayers:    Direct submission to tax agency/no third party involvement    Faster refunds    Tax preparation industry objections    Ensuring security of the system    Updates to system based on late tax law changes   Total costs for development of the system were approximately $1 million  to $2 million with an annual maintenance fee of $480,000 for individual and  business users. We found 20 states and  the District of Columbia provided I-file services.
Why GAO Did This Study

Some states and countries allow taxpayers to prepare and file tax returns on their Internet Web sites at no charge, an option not available to federal taxpayers. Such a service might mitigate the concerns taxpayers have about current electronic filing options, which require filing through a third party and may involve fees. Increased electronic filing would reduce IRS's paper processing costs, reduce transcription errors, and speed up refunds. However, the idea is controversial. IRS already has a Free File program which offers free return preparation and filing by private companies for some people via IRS's Web site. Some are opposed to IRS competing with tax preparation software companies. GAO was asked to (1) describe IRS's options for on-line preparation and filing (I-file) based on states' experiences; (2) determine the benefits and costs of I-file based on the experiences of the states; and (3) describe the potential for IRS to realize cost savings from I-file. GAO profiled 7 states and the District of Columbia, 2 foreign countries and 3 federal agencies to describe I-file options and determine their benefits and costs.

What GAO Found

The options available to IRS for implementing I-file system vary in technology, features, and eligibility. The states profiled all employed an interactive format on their Web sites for tax return preparation. The systems varied in whether they included features such as the ability to save and return. Systems also varied in eligibility, i.e. limiting income or residency. For the systems profiled, both reported benefits and costs were relatively modest and it is unclear whether benefits were greater than costs. I-file systems may generate benefits by increasing electronic filing and reducing filing fees for taxpayers. California and Pennsylvania estimated savings of $1.00 per return and $3.47 respectively per return converted from paper. However, the benefits were limited by low usage. I-file usage rates were less than 6 percent. Available data on I-file costs, while limited, shows costs are a very small percentage of state tax agencies' budgets. For example, California reported spending $700,000 to develop and operate CalFile from 2003 to 2005--less than 0.1 percent of the tax agency's annual budget. States kept I-file costs relatively modest by restricting eligibility and features. Several states used contractors to develop and operate their I-file system as well as provide the computer hardware. Low usage also contributed to modest costs. For example, some states said low usage meant they could use existing computer equipment. IRS's potential to realize net cost savings from an I-file system depends on the costs of developing the system and the number of taxpayers converted from paper to electronic filing. IRS's costs could be higher than the states'. First, the federal tax system is more complex. Second, unlike states which already had Web sites with Internet transaction capabilities, IRS would have to significantly upgrade its Web site and incur new security costs. Finally, developing an I-file system would further stretch IRS's capability to manage systems development, a GAO high risk area since 1995. Converting paper filers to electronic filing generates savings of $2.36 per return, according to IRS estimates. However, the number of paper filers who would convert is uncertain. The 13 million individual taxpayers who prepared their returns on a computer but then printed and mailed them to IRS are one target for conversion to I-file.