As tax season gets under way, filers are being tempted with a deal: Through Feb. 15, Americans can visit a local H&R Block (HRB) office and file their returns for no charge. No, the free returns are not a charity project, but a way to build foot traffic among early filers—many of whom will likely not be eligible for the deal anyway.
That's because the no-charge promo has an important caveat: It covers only those filing the 1040EZ federal form, about 16 percent of Block customers. The 1040EZ form handles the very simplest tax issues. It can't, for example, be used by anyone who has dependents, makes more than $100,000 per year, is 65 or older, claims adjustments to income such as alimony or tuition deductions, or itemizes deductions. So homeowners who deduct mortgage interest or people with large charitable contributions can't take advantage of the deal. "It's not about giving away business for free," explains Amy McAnarney, Block's senior vice-president for tax operations.
Until they arrive for an appointment, many of these new customers might not realize they need more complex tax forms. While they could wind up paying fees, McAnarney says some could also end up receiving larger refunds. "It's a win-win for the client," she says. Even customers who use a 1040EZ will have to pay Block extra to file their state income tax returns in the 43 states that levy them. Block hopes the promotion will attract younger taxpayers—those who can actually use the 1040EZ—and win their loyalty. The company estimates 55 percent of EZ filers will need to file a more complex form within two years.
A rise in joblessness has hurt business for tax preparers. Total IRS filings dropped 1.7 percent last year, the largest decline since 1971. The number of returns handled by Block retail offices fell 6.1 percent last year.
Morningstar (MORN) analyst Vishnu Lekraj says in-office tax preparation services continue to lose market share to tax software and websites, which can be much cheaper. "The taxpayer is becoming more and more comfortable doing their own taxes," he says.
The free filing promotion will replace Block's big marketing program of recent years, the Instant Money refund. Those "refund anticipation loans" let customers leave a Block office with a check immediately after filing, rather than waiting eight weeks for their IRS refund. But RALs have come under fire by the federal government and consumer groups for high fees and finance charges. Compass Point Research & Trading analyst Mike Turner estimates RALs cost Block's 2010 customers about $67 each, which works out to an annualized interest rate of 54 percent on an average $3,000 refund.
After Treasury Dept. regulators started cracking down, Block's lender, HSBC (HBC), announced it wouldn't fund the Instant Money program this year. That has left Block without the lucrative product, while competitors like Jackson Hewitt (JTX) still offer it, at least this year. Compass Point's Turner estimates Block could lose 10 to 15 percent of its RAL users; RALs account for about 5 percent of the company's tax revenues, he figures. Block will offer alternatives, including a refund anticipation check that can take eight days to clear, and a prepaid debit card.
Last year the average tax return at a Block retail office cost $189. Company executives don't expect that to decline in 2011, despite giving out free 1040EZ returns, because of the potential to sell customers more complex returns and other products. "Our ability to monetize this program means a minimal impact on our net average charge," Block retail tax President Phil Mazzini told analysts on Dec. 7.
Still, challenges remain. While Compass Point's Turner expects Block will stop losing business to the bad economy, he figures it will continue to lose customers to do-it-yourself computerized filing options. "I would expect their total filers to be down slightly year over year," he says.
The bottom line: H&R Block is preparing some tax returns for free. Restrictions on the promotion let it upsell other services, minimizing the revenue loss.