There has been much discussion of the failure of free file to deliver a free tax filing platform for low and moderate income taxpayers as initially promised. You can find some great articles on the topic here, here and here.
This post does not address whether the IRS and its free file partners have done a good job with the free file program. Rather, this post examines the attempt by the state of California to sue two of the free file participants under the unfair, fraudulent, and deceptive business practices act in that state. The Los Angeles city attorney’s office is currently suing (on behalf of California) both H&R Block (complaint here) and Intuit (maker of TurboTax) (complaint here) over their implementation of the free file program.
The existence of suits like those brought by California may have a greater impact on the free file program than the oversight by the IRS which, as described in the articles cited above, seems less than robust. If so, the lawsuit demonstrates a private litigation mechanism for changing some tax practice outside of the Internal Revenue Code, Congress and the ordinary administrative procedures. Perhaps the state will succeed and perhaps it will lose, but the existence of lawyers primarily versed in consumer law bringing actions to change tax administration shows another path, in certain cases, to success in changing the system.
California alleges several things about the free file program and these companies’ actions, which mirror the findings in some of the articles described above. It alleges that Block & Intuit took affirmative actions to keep the public from appropriate awareness of the program in violation of the terms and spirit of the Free File Agreement. It alleges that the free online program itself is inferior to another program with an almost identical name and that the companies made that program difficult to find. It also alleges Block & Intuit made misrepresentations and employed deceptive marketing schemes.
I’ll focus here on the Block litigation, which has been more procedurally complicated than the Intuit suit (which is ongoing in California Superior Court). California brought the suit against Block in state court, but Block removed the case to federal district court on the basis that the state law claim implicates significant federal issues. In this opinion the state seeks to return the case to state court and the federal district court agrees.
The court states that it must resolve all ambiguity in favor of remand to state court and that the party seeking removal to federal court bears the burden of establishing federal jurisdiction. For this case to move forward in federal court the party seeking to have it heard in federal court must show, among other things, that a federal question is a necessary element of the state claim.
California argues that its complaint does not necessarily raise a substantial federal issue and resolution in state court remains possible without disrupting the balance of federal and state responsibilities. Block argues that the relief sought necessarily depends on the interpretation of the Free File Agreement between Block, and other participants, with the IRS, a federal agency. The court says that mere presence of a federal issue in a state suit does not automatically grant federal question jurisdiction but becomes one of federal jurisdiction when the federal issue raised is “basic, necessary, pivotal, direct or essential to the claim.”
Block sees the federal issue as central since the agreement the state seeks to enforce is an agreement between Block and the IRS. The court discusses an earlier 9th Circuit case, Lippit v. Raymond James Fin. Servs., 340 F.3d 1033, 1040 (2003) raising an issue of deceptive practices in the selling of securities regulated by the SEC. In that case the 9th Circuit determined that the plaintiff merely had to show the defendant acted unfairly or fraudulently which did not raise federal issues.
The court finds the suit by California similar to the Lippit case. The proof of deceptive practices does not require an interpretation of federal law and the state court can properly decide the issue.
In the alternative, Block argued that even if the deceptive practices claim does not involve federal law, the other two claims in the case do. The court determines that as long as the case could be decided under a state law claim remand to the state is appropriate. The court looks at the unfairness part of the argument of California and determines that California could prevail on that claim irrespective of whether Block violated its federal agreement. Similarly, it determined that the fraudulent or deceptive practices claim could be decided without resort to the Free File Agreement.
So, a state court may have a say in what happens to the Free File program and attorney generals have a way to police the program, even if the IRS has fallen down on its job of doing so. In this somewhat rare area where state consumer law overlaps with IRS oversight, the consumer law provisions may provide a work-around to lax federal action and a path for taxpayers to actually receive the free file programs the program seemed to promise in its inception.