While a large number of tax software companies offer return preparation and electronic filing services, three companies provide the tax software used by the majority of individuals who prepare and file their returns electronically (see app. II). One company’s product—Intuit’s TurboTax— represented over half of the returns filed electronically by individual taxpayers. These and other tax software companies generally offer several versions of retail, online, and downloadable software packages that taxpayers can use to prepare federal and state tax returns. They generally charge less for versions that are designed to handle simple tax returns and charge more for versions that can prepare more complicated returns such as those dealing with business expenses. In 2008, the three companies also employed two basic pricing strategies. One strategy was to charge separate, incremental fees for federal return preparation, state return preparation, and electronic filing. For example, in 2008, one company charged about $40 for federal return preparation, with incremental fees of about $20 for electronic filing. The other pricing strategy used was to bundle several services together—typically return preparation and electronic filing—and charge one price for the bundle. Tax software is one of the three major methods that taxpayers use to prepare their returns. As figure 1 illustrates, over 39 million (or 28 percent) of the approximately 138 million individual income tax returns filed in 2007 were prepared by individuals using tax software. Over 77 million individuals used a paid preparer to prepare returns electronically in 2007, and 71 percent of those returns were also submitted electronically to IRS. The remaining 21 million returns were manually prepared by individuals or their paid preparers. After preparation, taxpayers can either electronically file their return or mail a paper copy to IRS. Figure 1 shows that millions of taxpayers who had a return prepared electronically (either by using tax software or a paid preparer) filed paper copies. Such returns are called “v- coded” because IRS codes such returns with a “v” to process and track them separately from other paper-filed returns. Many of the companies that sell tax software also have partnered with IRS to provide free electronic preparation and filing to eligible taxpayers. Those taxpayers have the option of filing their returns for free using products from the Free File Alliance, LLC (FFA)—a consortium of tax preparation companies that provides online electronic preparation and filing to eligible taxpayers at no charge. Figure 1 includes the approximately 4 million FFA returns filed in 2007 by individuals using commercial software. To help improve paper processing, about half of the state revenue agencies use a bar coding technology to convert data on paper returns to electronic data. Bar coding is less expensive and more accurate than processing paper returns because it eliminates manual transcription but is still more expensive and less efficient than electronic filing. IRS does not use this technology for processing individuals tax returns. Returns filed electronically have significant advantages for IRS and taxpayers compared to paper-filed returns as discussed below and further detailed in appendix III. IRS estimates that processing an electronically filed return costs the agency $0.35 per return while processing a paper return costs $2.87 per return. Using IRS’s current cost estimates based on fiscal year 2005 return data, we estimate IRS would have saved approximately $143 million if the 56.9 million paper returns in 2007 had been filed electronically. Electronically filed returns also have higher accuracy rates than paper- filed returns because tax software eliminates transcription and other errors. IRS processes electronically filed returns in less than half the time it takes to process paper returns, facilitating faster refunds. We have previously reported that electronically filed returns have the potential to improve IRS’s enforcement programs. IRS does not use all tax return information in its automated compliance checking programs because IRS policy is to post the same information from electronic and paper returns, and the cost of transcription prevents IRS from transcribing paper returns in full. IRS officials previously estimated in 2007 that having all tax return information available electronically would result in a $175 million increase in tax revenue annually from at least one of its compliance programs. IRS recently issued the results of the first phase of its Advancing E-file study, which examines tax filing behavior and characteristics and contains potential options to increase electronic filing. We have previously reported that IRS’s ability to achieve efficiencies depends on its continuing ability to increase electronic filing. We recently suggested that Congress mandate that paid tax return preparers use electronic filing and that IRS require software companies to include bar codes on individual paper returns. IRS agreed to study the latter option. IRS has responsibility for enforcing tax laws in the Internal Revenue Code (IRC). In addition, IRC section 6011 provides specific authority for IRS to prescribe forms and regulations for tax returns, including the information required on those returns and whether they must be filed electronically. The IRC imposes civil and criminal penalties on paid tax return preparers, which include tax software companies, for unauthorized disclosure or use of a taxpayer’s personal and tax-related information. In addition to tax law penalties, the providers of services for preparing and filing tax returns are subject to the privacy and safeguarding rules created under the Gramm-Leach-Bliley Act (see app. IV). For the 2009 tax filing season, the two largest tax software companies that previously charged separate electronic filing fees for federal returns in some of their retail and downloadable products have eliminated those electronic filing fees. Moreover, the three largest companies will bundle federal tax preparation with electronic filing for all of their products (see app. II). However, for some products, the companies will still charge separate, incremental fees for other services such as state return preparation, state electronic filing, and return review by a tax professional. According to industry representatives, IRS officials suggested they eliminate separate federal filing fees to encourage electronic filing. However, the effect of these changes on electronic filing will not begin to be known until the end of the present tax filing period and will be difficult to determine. On one hand, taxpayers who buy a tax software package that includes a bundle of services may be encouraged to use software and file electronically because there is no longer a separate charge for doing so. On the other hand, if the cost of such a package is significantly higher, it may discourage taxpayers’ use of tax software since they may not be able to purchase a less expensive package that does not include electronic filing. The two largest tax software companies that eliminated federal electronic filing fees also made some other pricing changes for preparing and electronically filing both federal and state tax returns in 2009 including: online tax packages are generally priced lower than in 2008; online tax packages are generally priced lower than most retail/downloadable packages remained essentially the same in price when compared to 2008. For the third largest tax software company, its package prices for both online and retail/downloadable products remained the same in 2009 as in 2008 because the preparation and electronic filing fees remained the same in both years. See appendix II for more details. Another change in 2009 is that IRS and FFA have agreed to provide a fillable version of federal tax forms. These fillable tax forms, which taxpayers can complete online and file electronically, will provide a basic calculator function but will not provide the question-and-answer format similar to commercial tax software. The forms will be accessible for free to all taxpayers via IRS’s Web site and are in addition to FFA’s current free products for eligible taxpayers described in the background of this report. As part of the upcoming second phase of its Advancing E-file study, IRS plans further surveys to obtain taxpayers’ views on electronic filing. However, it does not plan to include questions, for example, about the effect of 2009 pricing changes on taxpayers’ willingness to file electronically. Currently, IRS has little such information. For example, IRS and the Oversight Board surveys to date have not addressed how a separate charge for electronic filing affects taxpayers’ willingness to file electronically. With the 2009 changes, however, IRS has an opportunity to directly measure the effect of eliminating separate fees to file federal tax returns electronically, making changes to software pricing overall, and making electronic tax forms available so that all taxpayers can complete and file for free online. We recognize that such a direct study would not be simple to conduct because, for example, it may be difficult to isolate the effect of multiple price changes and factors other than price, such as accuracy and security, which also affect taxpayers’ willingness to file electronically. Further, prior year data are limited. However, even limited information about how taxpayers’ electronic filing behavior changes after price changes would give IRS an empirical basis for supporting the continued elimination of separate fees for electronic filing and other pricing changes as well as complementing surveys of taxpayers’ views. Ideally, to study the effect of pricing on electronic filing rates, IRS would need to know the software package and version used by each taxpayer in order to know the approximate price paid. Currently, IRS requires a software identification number on electronically filed returns, which does not identify the specific software package or version used to prepare those returns. IRS does not require any type of software identification number on v-coded returns (returns prepared using software but filed on paper). Having a more complete software identification number would not only allow IRS to better target its research but also its enforcement activities and efforts to increase use of tax software and electronic filing. Officials from one software company told us that such a change could be easily made by their company at a relatively low cost. In its Advancing E-file study, IRS reported that one of the most important factors influencing taxpayers’ use of tax software is its ability to accurately apply tax laws. IRS requires tax software to pass its Participants Acceptance Testing System (PATS), which includes verifying that computations are correct, tax rate schedules are updated, and returns transmitted electronically are compatible with IRS systems. However, PATS does not go further in testing to determine, for example, whether the guidance tax software provides is sufficient in helping taxpayers prepare accurate tax returns. IRS developed a National Account Manager (NAM) position in 2000 to serve as the main communication channel between the tax software industry and IRS.