July 10th, 2023
The IRS is developing a free direct e-file tax filing system called Direct File. Before developing a full-scale product, the IRS conducted surveys and research for the new tool. In May 2023, the agency sent a report to Congress with its findings. The report detailed taxpayer interest in a free government-provided system, the cost the IRS would incur to operate the system, and the logistical challenges the agency would need to address to implement it. An analysis by an independent third party was also included in the report. This study is the first step in deploying this free tax preparation system. The agency also plans to operate a pilot program to test the new service for the 2024 tax filing season.
The IRS currently offers an electronic filing system on its website called IRS Free File. This system is available for tax filers with an AGI of $73,000 or less. However, despite this free offering, not many taxpayers utilize it.
Before rolling out a new system the IRS surveyed 4,219 randomly selected individuals who filed a 2021 federal tax return in 2022. The survey described the hypothetical free file system and asked the taxpayers to respond to questions regarding their opinions, expectations, and level of trust in the proposed tool.
The survey found that many taxpayers are interested in using an IRS-provided tax preparation service but would expect it to be as easy to use as the commercial tax preparation software that is already available. Those interested in the tool indicated that cost is a significant factor in selecting a tax filing service, with most saying they would opt for the free IRS version over a commercial one that costs about $80. The surveyed taxpayers also stated that data security is a concern, with some worried commercial software companies may sell their information to third parties but trusting the IRS would not do the same.
The research notes the primary response provided for why taxpayers would be unlikely to use the tool is that they are comfortable with the software they already use. Other reasons for not using the system include taxpayers don’t believe it is the role of the IRS to prepare taxes, the customer service of the commercial software they already use is better than what they expect the IRS to offer, or they already prepare their returns for free.
The IRS estimates the cost of implementing and maintaining the Direct File system to be between $64 million and $249 million. The lower estimate assumes only 5 million taxpayers will use the system, covering a narrow range of tax situations. The higher estimate assumes 25 million taxpayers will use the system with a broader range of tax situations covered. To calculate these costs, the IRS considered several factors in its estimate, including the cost of developing and maintaining the technology, the complexity of the tax situations for its users, and customer support costs. The IRS notes that the wide range of costs is due to the many uncertainties of deploying a tax service of this scope.
In addition to gauging taxpayer interest and estimating costs, the report notes logistical concerns that the IRS needs to address to implement the Direct File system. One of the main concerns is customer support. To implement the tool successfully, the IRS must provide varying levels of support, from answering tax questions to troubleshooting software issues.
Building and maintaining the software and technology presents additional challenges for the IRS. It must ensure the product is current with tax legislation updates and securely maintains taxpayers’ private information.
Another obstacle is addressing how the Direct File system interacts with taxpayers’ state filings. Most taxpayers expect to be able to file their state returns in conjunction with their federal tax returns. Integrating federal and state filings requires the IRS to collaborate with state and local tax administrators, which creates additional challenges.
The IRS announced that it plans to operate a pilot program to test the new system for the 2024 tax filing season. The pilot program’s goals are twofold: to gain more information before deciding whether to move forward with the full-scale model of the project and to test the product’s capabilities before widespread use.
The IRS can gather information on the tax situations of the taxpayers using the product to decide the level of complexity the product will offer. It will also allow the IRS to address the technological and customer service-related concerns mentioned previously. IRS commissioner, Daniel Werfel, stated more information about the pilot program will be available in the coming months.
A concern for private-sector tax preparers is how they will be affected by a government-provided free tax preparation tool. The IRS commissioner noted the IRS Direct File system should supplement and not replace the tax software already available including private-sector software, non-profit tax services, and the free IRS paper file option. The tool is voluntary and will serve as another option for taxpayers to use to file their tax returns. There will likely be taxpayers who do not wish to switch from their current tax provider or, depending on the capabilities of Direct File, some taxpayers’ tax situations may be too complicated even to use the product. Tax preparers should expect to be needed and consulted by taxpayers even after Direct File is active.
A free IRS-provided tax filing system can be a valuable tool for many taxpayers as it would provide a convenient and reliable way to file a tax return with the IRS. However, implementing the system successfully and adequately will present challenges the IRS must address before it becomes available to the public. Many issues still need to be answered regarding the scope of the tax situations the tool will provide. Updates are expected to be forthcoming as more information is released about the system and pilot program.
By Ashley Akin, CPA
Sources
IRS Report to Congress: www.irs.gov/pub/irs-pdf/p5788.pdf
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