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Jeff Schnepper

The Basics

Free tax filing could cost you

The IRS' Free File program can help many taxpayers complete their federal returns easily. But not all taxpayers are using it, probably because of security concerns.

[Related content: taxes]
By Jeff Schnepper
MSN Money

The Internal Revenue Service's Free File program brings back words of wisdom I once received from my father: "Whenever you get something for free, be careful. You're probably not getting your money's worth."

Debuting in 2003, Free File is a consortium of tax-software vendors that prepares individual tax returns for free on the IRS Web site. Here's the good news:

  • American taxpayers with an adjusted gross income of $57,000 or less are eligible for Free File. Each of the vendors sets its own criteria for who can use the service.
  • You can use Free File to request an extension to file with Form 4868 (.pdf file).
  • Free File is available in Spanish.
  • The only thing vendors are allowed to charge for is the preparation of state returns. Vendors are no longer allowed to charge for ancillary tax-return services or offer refund-anticipation loans (RALs). In the past, an RAL for an average refund of $2,500 would cost about $100 from some tax preparers. According to Chi Chi Wu, a staff attorney for the National Consumer Law Center, that would translate into an effective annual interest rate of 150% for the time the loan was outstanding.

Before, fees had been charged not just for preparing and filing state tax returns but also for such services as password resets, live help or telephone technical support, professional tax-return reviews, audit protection, amended returns and consultations.

This new, "cleaner" Free File system is not without its temptations, however. Once you're transferred to a vendor's Web site, you're given the choice of filing your federal taxes for free, with no other offers, or viewing "value-added products" from the vendor. Such products have included offers for mortgage financing, individual retirement accounts and even a link for you to sign up for a tax-preparation franchise -- with no experience necessary -- for $15,500!

You understand, the IRS folks are from the government, and they're here to help you. Whenever something is offered for free, you should at least consider it. But don't forget the potential downsides.

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Couple preparing taxes © Corbis
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While millions have used Free File for their tax returns, there's still a lot of fear of electronic shenanigans out there. And it may be justified. A January 2009 report from the Treasury Inspector General for Tax Administration concluded that the IRS had implemented a new electronic filing system knowing it contained security vulnerabilities that could put taxpayer information at risk.

Electronic versions of tax returns are susceptible to theft in a number of ways, including:

  • The traditional computer hacker penetrating a network's security system.
  • Unauthorized users accessing tax-return files by tapping into wireless networks. Such networks allow anyone using the network to get into files on computers that are part of the network.
  • Use of peer-to-peer software. Such software installed on one computer allows files to be shared with computers having similar software.

Continued: You can now file on the Web

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