Millions of Americans are gearing up for the 2023 tax filing season, perusing their options for getting their tax returns done accurately and on time.
Those confident to file their taxes by themselves often turn to tax software: 90% of tax returns are electronically filed (e-filed) through commercial tax software, volunteer income tax clinics, tax preparation services, and private tax advisors.
The IRS estimates that 70% of taxpayers qualify to e-file their taxes for free with FreeFile, which is available to taxpayers who have adjusted gross income under $73,000 for the 2022 tax year. However, less than 3% of eligible filers actually use it.
There are myriad reasons for this massive disparity. Awareness of the program is a significant factor. Big-name commercial tax software providers also poorly communicated their participation in the FreeFile Alliance, which made it challenging to find participating providers. Notably, household names TurboTax and H&R Block departed in the early 2020s. Of the eight providers left, the most well-known among individual tax filers is TaxAct.
All FreeFile providers institute their own eligibility criteria for free tax filing since the IRS only mandates an income cap, not taxpayer categories or states of residence. Self-employed taxpayers virtually always have to pay to file. Living in states with complex tax codes, such as California, also usually disqualifies otherwise-eligible taxpayers from free tax filing.
But there is another reason why millions of taxpayers instantly opt for a commercial solution, aside from confusion over FreeFile.
Most taxpayers want some degree of surety that if they make a mistake on their tax return, it will be easy to fix. For decades, the mass media struck the fear of the IRS into people's hearts. Understandably, many may feel uncomfortable sending self-prepared tax returns directly to the government.
But if they can also talk to a tax professional without having to pay onerous fees to a personal tax advisor during tax practices' busiest season, it makes commercial tax software packages all the more appealing.
Enter audit protection plans.
What Is an Audit Protection Plan?
Audit protection plans are add-on services that can be purchased through a tax software provider. Typically, they can be selected for purchase through the program right before or after your tax return is ready for e-filing. If you outsourced your tax return to a tax preparation chain like H&R Block, you may be asked by phone or in person if you'd like to add their protection plan to your service.
These plans tend to cost $40-60 per annual tax return. Depending on the software provider and the software grade and level of service you purchased, it may cost more. These factors will also affect any benefits you receive.
There is a specific reason these tax software add-ons were dubbed “protection plans” and not “insurance.”
Ultimately, you are responsible for everything on your tax return, even if you hire a professional. However, this is doubly so when you take matters into your own hands and self-prepare. Even if you truthfully answer all the questions the software asks and fill out the forms to the best of your ability, you or the program can still make mistakes. Neither the IRS nor Tax Court will accept “My tax software let it go through” as a defense for accidental errors, or even well-intentioned mistakes, that resulted in them making changes to your tax return that didn't go in your favor.
Audit protection plans cannot be an actual form of insurance in the legal sense. If you get audited, they can't help you if you owe money as a result! This is why, depending on the provider and what the audit protection plan offers, audit protection plans gently toe the line between “marginally useful financial service” and “an outright scam.”
What Do Audit Protection Plans Usually Include?
The author looked closely at two popular audit protection plans, H&R Block's Worry-Free Audit Support plan, and TurboTax MAX.
H&R Block's Peace of Mind plan is for users who have an H&R Block tax professional to prepare their tax returns. Representation from a credentialed tax professional is available if you purchase the plan, along with correspondence for IRS notices within 60 days of receipt. H&R Block will also reimburse up to $6,000 if the tax professional made an error on your tax return, but this does not happen if you omitted or misstated information.
Worry-Free plans do not reimburse users or provide any representation services. There are additional fees if you need a tax expert to help you with a self-prepared return or IRS correspondence. You mostly get phone support that walks you through responding to IRS notices and extensive audits. Ironically, with numerous search pages dedicated to “transparent pricing,” there is no price for Worry-Free audit support listed anywhere on the company's website.
TurboTax offers annual memberships for audit defense rather than one-time purchases that are only good for the tax year in question. For $59, TurboTax MAX offers priority customer care with TurboTax product specialists, identity theft monitoring, and identity restoration. They also provide audit representation services similar to H&R Block.
Most lesser-known competitors offering similar audit protection plans are limited to extended product support and phone support walkthroughs rather than actual representation from a qualified tax professional.
But how likely are you to need the service? What is your probability of actually getting audited?
Difference Between an Audit and an Examination Notice
According to IRS statistics, very few tax returns are selected for audit in the first place.
In the 2021 tax year, fewer than 160,000 field examinations were performed. Field examinations are the traditional IRS audit you've seen in movies, where an agent comes to your home or place of business and thoroughly examines every line item of your tax return.
Over half a million audits were completed by mail, known in the tax field as “desk audits.” Desk audits usually involve a specific tax form or item that requires more information to defend your deduction or stance. These are the matters concerning deductions the IRS thinks could be off that tend to get escalated to IRS appeals, later Tax Court. They tend to lead to landmark cases like Soliman v. Commissioner, which solidified the right for self-employed people to deduct their home offices.
Most tax return discrepancies are resolved through the IRS' automated underreporter (AUR) program, which catches discrepancies such as accidentally reporting a stock trade as $4,600 instead of $6,400. While no one likes to see mail from the IRS, this isn't actually an audit that requires retaining specialized representation.
So Are Audit Protection Plans Just Scams?
Most people with tax situations simple enough to confidently self-prepare their tax returns tend not to be in groups that are common audit targets. Many users buy these plans for peace of mind, nothing more.
But even if you gain temporary access to a qualified tax professional through a protection plan, it isn't a guarantee you'll have a successful outcome or that they can handle your case promptly.
You also might not have the best representation to deliver a solid defense because you're working with a tax expert handling large volumes of overflow queries. They aren't forming a one-on-one tax professional relationship with you, where it's their job to become familiar with their client's financial situations and advocate for them.
Even if the audit protection plan gives you access to a qualified tax professional, they are only paid to help you with a specific problem rather than research or defend highly-specific and complex tax issues.
If your audit protection plan only offers “IRS response gameplans,” you can easily find that information for free on most tax advisor blogs and financial websites. Ultimately, these plans buy you enhanced product support rather than material help with the IRS.
For many providers, these plans narrowly evade being labeled scams by providing enhanced product support. They are simply another revenue stream that capitalizes on an overly complicated tax system, similar to how participating providers conveniently did not mention FreeFile.
This article was produced and syndicated by Wealth of Geeks.