WASHINGTON (TND) — The IRS will be experimenting with a new pilot system next year allowing Americans to file their tax returns directly with the agency instead of going through a tax preparation service.
Having a system to prepare and file taxes with the IRS would be a significant shift from the longstanding way Americans are used to filing during tax season.
Proponents of a direct file system say it would help taxpayers deal with an increasingly complicated system and incentivize digital returns that are faster and easier for the agency to process. Critics say it is a conflict of interest for the IRS to prepare and enforce tax laws and that implementing its own direct file system is too costly and unnecessary.
The U.S. also has one of the highest voluntary tax compliance rates in the world among developed economies, raising questions about how necessary a new system is.
The IRS’ report and announcement of a pilot program stems from a provision in the Inflation Reduction Act that also provided the long-term infusion of cash for the agency.
“Ultimately, the results show there is taxpayer interest in an optional direct file program and such a program is technically feasible. Any path forward should start with a limited pilot to assess operational factors described in this study,” IRS commissioner Danny Werfel said.
Republicans who have been resistant to giving the IRS more funding and have been supportive of efforts to strip the $80 billion in debt negotiation talks criticized the plan to test a pilot system.
“Having the IRS act as tax preparer, tax collector and tax enforcer raises significant conflicts of interest, would incur billions of dollars in development costs, and would expose exponentially more taxpayer information to misuse or abuse, providing hackers and identity thieves yet another IRS outlet to exploit,” Sen. Mike Crapo, R-Idaho and ranking member on the Senate Finance Committee, said in a statement. “Despite tax preparers providing tens of millions of free returns a year and having a fully functional Free File program at virtually no cost to taxpayers, the federal government entering into the software tax preparation business is an unnecessary expense that will only add to an out-of-control deficit.”
Crapo also questioned if the IRS has legal authority to implement a direct e-file system without congressional authorization. Getting a bill through a split Congress with parties that have little common ground on tax policy would be a significant hurdle for a permanent direct file system.
The IRS’ report included a survey of taxpayer attitudes toward a free file program, which found that a majority would be interested in using a tool provided by the agency. Support for the program dipped in a scenario where the final IRS program wouldn’t include filing state taxes.
“State taxes preparation are going to cost me money, so the IRS being free no longer offers any value,” one respondent said when presented with the scenario.
Estimates on the cost of the program varied widely depending on how many people used it and how advanced the software would need to be. Ranges of annual cost estimates for the product and customer service range from $64 million on the low end to nearly $249 million for the most expansive scenarios.
The estimates on how much the program would cost do not include savings from a reduction in paper returns, which could represent significant savings for the agency. Despite only 8% of returns being on paper, they account for nearly 70% of total processing costs. A single paper-filed 1040 form costs $7.33 to process, while a digital version is $0.28.
Some critics said it is redundant because a free tax filing service is offered by private tax preparation companies through an agreement with the IRS called the Free File Alliance, though two of the largest companies in Intuit and H&R Block have pulled out of it in recent years. The alliance prevented the IRS from creating its own free-file service if the companies provided it for people making $73,000 a year or less.
Proponents of an IRS-operated system point to the low participation rate for the existing free file option as part of the need for a new system. A Government Accountability Office report last year found only 3% of taxpayers take advantage of the Free File Alliance Service despite 70% of them being eligible for it.
Private companies in the alliance have also come under scrutiny for barriers to filing returns and advertising free services before charging a fee when a return requires more than the most basic services.
The report was met with stiff resistance from tax prep giants Intuit and H&R Block, which stand to lose significant business if a wide swath of taxpayers were to take up an IRS-provided service.
“The IRS direct e-file pilot set to start in January 2024 continues to be a solution in search of a problem,” H&R Block said in a statement. “With more than 30 organizations already offering free tax preparation, this pilot is unnecessary and faces significant barriers to providing comprehensive tax preparation services. H&R Block remains committed to helping millions of Americans get the best outcome at tax time.”
An intuit spokesperson said the IRS report is “not grounded in reality.”
“The study ignores the harm a government-run system will have on vulnerable taxpayers and the true costs to taxpayers. The costs estimated in the study to build, operate, and maintain are laughable,” Intuit spokesperson Derrick Plummer said in a statement. “The study cherry-picks data to support its flawed conclusion ignoring that only 12% of taxpayers said they would use a government-run system if state returns are not included.”
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