Many taxpayers like the notion of a do-it-yourself plan for preparing and filing their tax returns digitally for free through an IRS-run system. Just how many would use it, though, who honestly knows? And don’t bank on an expanded, quick rollout of a new “Direct File” option soon, based on findings in the Internal Revenue Service’s report to Congress.
The IRS will launch an initial, limited pilot in 2024, according to IRS and Treasury officials who spoke during a briefing Tuesday. The size, scale and structure of the pilot isn’t known yet. No details were given for how many taxpayers would be able to file online directly with the IRS next year. Or how the IRS might reach out to those who might be asked to participate or want to volunteer to file their 2023 tax returns next year through the pilot system. The IRS said such details are expected to be determined later.
The report noted that a successful pilot requires a clear scope, a target audience and measurable goals up front. The pilot would be used to determine if or how a full-scale “Direct File” project could move forward.
The Inflation Reduction Act, signed by President Joe Biden in August 2022, mandated that the IRS conduct a feasibility study to determine how the federal government might develop and run a free, direct electronic filing tax system that’s open to all consumers.
The act, which allocated $15 million for the study, required that a report be completed by mid-May.
Taxpayers want free options
Laurel Blatchford, chief implementation officer for the Inflation Reduction Act at the Treasury Department, said the research indicated there’s an appetite among taxpayers for a free direct-file tool from the IRS. She noted that dozens of other countries have provided free filing options to their citizens.
“Taxpayers would prefer a free option provided by the IRS,” Blatchford said.
A free-file option built by the IRS could cost less than $10 per return to provide, she said, and would be free to taxpayers. By comparison, she said, simple electronic filing options currently available to taxpayers are around $40.
The report pointed out that it is unknown how many taxpayers would actually tap into the a new digital IRS system. Given the “substantial uncertainty,” the IRS report outlined various cost estimates based on a range of 1 million to 25 million users.
“Even some of the largest technology companies in the private sector (such as Meta, Dropbox, Twitter, and Airbnb) have taken months, and sometimes years, after launching to the public to reach 1 million users,” the report noted.
If the pilot moves forward, taxpayers can expect to see “Direct File” evolve over time.
“To be successful, the IRS would need to test, grow, and improve functionality over multiple tax years,” according to the report released Tuesday.
The IRS stressed that a free digital option would remain as just one option for doing your taxes.
“Taxpayers will always have choices for how they file their taxes,” IRS Commissioner Danny Werfel said in the press briefing Tuesday.
“They can use tax software. They can use a trusted tax professional. They can use a paper tax return. We’d rather they file it electronically, sure, but they have that tool. People should use the filing option that works best for them.”
The ‘Free File’ system continues
Werfel said the current IRS “Free File” system, which was created in 2002, will remain in place, noting that agreements were extended through 2025. Free File is offered through a partnership with tax software providers that make their online products available in English and Spanish for free at IRS.gov. This year, seven partners provided IRS Free File online products to any taxpayer or family who earned $73,000 or less in 2022. To find providers, taxpayers need to go to IRS.gov/freefile.
Participating companies in “Free File” receive no payment for providing these services. The IRS initially agreed not to create its own free tax-filing software as part of this deal. In 2019, though, the limitation on the IRS was removed.
Some 2.5 million taxpayers — or less than 3% of those eligible — used “Free File” in 2019, according to an audit conducted by the Treasury Inspector General for Tax Administration. Some maintain that consumers weren’t aware of the program. But some companies also have been criticized with re-directing tax filers online to their own products over the years that had a fee.
How ‘Direct File’ might work
The “Direct File” discussions go further to offer an IRS-run system and provide free services to more taxpayers. The goal is to test different approaches in the pilot, including the complexity of the returns.
Werfel said the initial pilot next year is not expected to pre-fill parts of tax returns with limited data that the IRS might already have about a taxpayer from a third party, such as wages on a W-2 form.
While a million or more taxpayers would be a decent-sized group for a new IRS-run system, it’s important to realize that individual taxpayers submitted nearly 160.6 million tax returns to the IRS during fiscal year 2022.
On average, the report noted, a taxpayer spends roughly 8 hours and $140 in out-of-pocket costs just to prepare and file their return, including all forms and schedules for non-business income. The burden on taxpayers who own a business or work in a gig economy is even greater, according to Treasury officials.
Not having to spend extra cash to file could be very attractive to many people but again, not everyone.
“A potential Direct File option could directly benefit taxpayers by making tax filing a simpler and less expensive process,” the report stated. The IRS also hopes that a new system might help discourage people from filing paper returns, which remain costly for the IRS to process.
The IRS receives 8% of returns on paper but, the report noted, that the cost to process those returns is nearly 70% of total processing costs.
The IRS and the U.S. Digital Service, a technology unit of the White House that provides consulting services to federal agencies, built a functioning, internal prototype system for limited research in controlled testing; no real tax information was used in these early tests. The prototype was not used to submit actual returns.
What are the risks?
Mark W. Everson, a former IRS commissioner and current vice chairman at the tax consulting firm alliantgroup, said the IRS will need to move cautiously in testing a “Direct File” program.
“Whatever is done here it has to be done very carefully,” said Everson, who was IRS commissioner from 2003 to 2007.
“It should be rolled out only as the service feels that it’s a product that’s ready to go.”
When turning to an IRS online system to prepare a return, he said, a taxpayer would often provide more information beyond what ends up being provided on a return or form that’s filed.
“How do people feel about the government having that information?”
It’s more sensitive information that the IRS needs to protect from data breeches or potential misuse.
“They absolutely have to be 100% confident that they can protect the data that they’ve accumulated,” he said.