The Internal Revenue Service has quietly built its own prototype system to allow Americans to file tax returns digitally and free of charge, according to three current and former agency officials, essentially creating government software that could disrupt the tax-prep industry.
The system will be available through a pilot program for a small group of taxpayers by January, when the 2024 filing season begins, said the people briefed on the matter, who spoke on the condition of anonymity to discuss internal agency conversations. It was developed by the IRS and the U.S. Digital Service, the White House’s technology consulting agency.
Last year’s Inflation Reduction Act, one of President Biden’s chief legislative victories, included $15 million for the IRS to look into creating a direct-filing program.
Treasury Department representatives declined to comment Monday.
“There’s something very important about the fact that even beyond making it easy and beyond making it free, this is something you could do directly with your government,” said Gabriel Zucker, associate policy director for tax benefits at the advocacy group Code for America, which has constructed its own tax-filing prototype.
The IRS currently refers people seeking no-cost filing options to a consortium of companies that provide free e-filing for taxpayers below a certain income level. Though 70 percent of taxpayers qualify for those products, known collectively as IRS Free File, fewer than 3 percent of taxpayers use them, according to a Government Accountability Office report.
For a narrower range of taxpayers, industry giants Intuit TurboTax and H&R Block offer free products that the IRS does not officially endorse.
Other filers can complete “Free File Fillable Forms,” digital versions of hard-copy IRS paperwork, without professional guidance.
The tax agency tapped the left-leaning New America think tank to study a direct-filing system and produce a report, which is expected this week.
IRS Commissioner Daniel Werfel had previously told lawmakers that the IRS would consult Congress after the think tank made its recommendation and had not yet determined whether to pursue its own software program. But if the IRS already has a prototype before the New America report has been released, “this suggests a pre-determined outcome and flies in the face of previous commitments Commissioner Werfel made to publicly consult Congress on a potential free-file solution, and for the IRS to not act without explicit legal authority,” said Idaho Sen. Mike Crapo, the top Republican on the Senate Finance Committee.
A free filing system offered directly by the federal government could upset a commercial tax-prep market estimated by the research firm IBIS World to be worth $14.4 billion this year.
“No matter the outcome of direct file, Free File is here to stay,” said Tim Hugo, executive director of the Free File Alliance industry group.
The system of commercial programs for online filing has served taxpayers and the government well by many accounts. Roughly 9 in 10 individual tax returns were filed digitally in 2022, the IRS reported. The U.S. voluntary tax compliance rate – the proportion of filers who pay federal taxes accurately each year – of 85.1 percent is one of the highest among developed economies, according to years of research in the United States and Europe.
But some experts say the private-public partnership also reflects the IRS’s technological deficits. Far smaller countries, including Estonia, Chile and Australia, offer government-backed digital filing services.
The Inflation Reduction Act granted the IRS $80 billion over 10 years to increase enforcement efforts for high-income earners, improve taxpayer services and modernize its technology. The Biden administration said the IRS needs the additional funds to catch up with sophisticated tax cheats and better serve low- and middle-income Americans entitled to a bevy of credits.
“You’ve got to develop this so it’s comprehensive,” former IRS commissioner Mark Everson said in an interview. “If it’s just treating the more simplified [tax returns], what about the more complex sets of circumstances? Somebody is going to say, ‘I’m not going to bother.'”
The agency plan also would allow taxpayers to solicit help from customer service representatives through secure online portals. That threatens to encroach on another area where tax-prep companies try to differentiate themselves from the IRS by employing legions of accountants and other experts to serve filers in premium product lines or develop software tools to guide filers while completing their returns.
“Is there a need for government to come compete with and change a functioning private-sector industry?” said Timur Taluy, chief executive of Free File vendor FileYourTaxes.com and a member of an IRS consulting panel of online tax-prep experts.
Industry representatives have been outspoken to lawmakers and administration officials about the direct-file program.
“A direct-to-IRS e-file system is wholly redundant and is nothing more than a solution in search of a problem,” Intuit spokesman Rick Heineman said in a statement, “and that solution will unnecessarily cost taxpayers billions of dollars.”
Intuit spent $1 million between January and March lobbying both House and Senate lawmakers on issues including “tax system integrity” and “intellectual property protections,” according to disclosures.
This month, Intuit began making payments to 4.4 million low-income Americans as part of a $141 million settlement to resolve claims that it misled taxpayers and diverted them away from free products to premium services. Under the terms of the settlement, the company did not admit wrongdoing.
H&R Block spent $720,000 over the same period on lobbying around various anti-poverty tax credits, “tax administration” and “Internal Revenue Service funding,” according to its disclosure paperwork.
“Today, the consumer has great choice and flexibility in where they turn for free help, with more than 30 organizations offering free tax preparation, half of which are non-profit organizations,” H&R Block spokeswoman Angela Davied said. “We remain committed to delivering the digital capabilities and human expertise and care that helps millions of Americans get the best outcome at tax time.”
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