IRS will launch test run of free online tax-filing system

The IRS announced Tuesday it will launch a test run of a direct, free online tax-filing system for the 2024 tax season, citing high levels of taxpayer interest in such a system and relatively low cost. 

In a highly anticipated Tuesday report, the IRS announced it forged ahead and built a prototype of a system that it will deploy in a pilot program.

The program will involve a select number of taxpayers and have a limited scope and functionality to allow the Treasury Department to gauge how taxpayers would interact with it, IRS and Treasury officials said Tuesday.

“Dozens of other countries have provided free tax-filing options to their citizens, and American taxpayers who want to file their taxes for free online should have an acceptable option,” said Laurel Blatchford, who heads the Treasury Department’s office for implementing the Inflation Reduction Act.

The Inflation Reduction Act boosted IRS funding by $80 billion and ordered the agency to issue a report on the feasibility of a direct tax-filing system.

Such a program could allow taxpayers to prepare and file their taxes without the use of popular tax preparation companies, which have spent millions of dollars to defeat previous proposals.

Why the IRS may shake up tax filing

The report found significant interest among taxpayers for a free tax-filing service from the IRS, which IRS officials now refer to as “Direct File.”

“Seventy percent of the public is interested in a free option deployed by the IRS, so we think there will be excitement there,” Blatchford said. “When the Treasury Department was evaluating whether to go forward with this pilot, it was very clear from the initial taxpayer data that there is real interest.” 

A survey conducted by the IRS as part of the report found 72 percent of taxpayers would be “very interested” or “somewhat interested” in using the direct file service.

The survey also found 68 percent of people who prepare their returns would be “very likely” or “somewhat likely” to switch to a free online tool from the IRS.

Big impact, small expected price tag

The report put the cost of the direct file system at just a fraction of the $80 billion budget boost the IRS received as part of the Inflation Reduction Act, most of which is going to additional enforcement capabilities. 

“Annual costs of Direct File may range from $64 million (assuming 5 million users and a narrow scope of covered tax situations) to $249 million (assuming 25 million users and a broad scope of covered tax situations),” the report found.

That money will come from the IRS’s technology and products budget, as well as its customer support budget. IRS Commissioner Danny Werfel said that systems modernization funds allotted in the Inflation Reduction Act could also be used to bolster the system.

How Direct File works

The fact the IRS already receives taxpayers’ personal information is one of the main reasons taxpayers would feel confident using the IRS system, the report finds.

Despite all the information on taxpayers the IRS already has on file, Werfel said Tuesday the direct file prototype likely would not use pre-populated forms to further automate taxpayer interaction with government software.

“Given that it will be limited in scope, we do not expect pre-population or predetermining tax obligations to be part of it,” Werfel said.

That likely means the format of the prototype software will be question-and-answer-based, similar to numerous pieces of commercial software, as the IRS’s recent strategic operating plan for its expanded budget indicates.

Who can use Direct File?

Tuesday’s report provides several scenarios the Direct File system could be asked to handle, ranging from basic wage income that’s taxed with the standard deduction up to more complex situations involving state returns, but Werfel said the exact cases of different taxpayers who could use the system will be further worked out in the pilot program.

While U.S. tax laws number in the millions of words and span tens of thousands of pages, nearly 90 percent of all filers use the standard deduction. Wages and salaries are taxed at 99 percent compliance while business income, rents, royalties and capital gains are misreported at significantly higher rates, suggesting the Direct File system might handle the vast majority of common tax situations.

This has led the Government Accountability Office, the National Taxpayer Advocate and many academics in the tax world to recommend a direct file option for taxpayers going back years. 

The IRS’s Free File program, which was an agreement between the IRS and a consortium of private tax prep companies, has provided free commercial software to lower-income people since the early 2000s.

But only a tiny fraction of eligible taxpayers have used it, leading to allegations of deceit and a $141 million settlement paid by TurboTax maker Intuit to taxpayers across nine states.

Lawmakers divided over IRS e-filing

“The IRS established the free e-filing program in 2003, but it did so in partnership with major tax preparation software companies that frequently mislead taxpayers into paying for their services,” Rep. Brad Sherman (D-Calif.) said in a letter to Werfel in a letter this week, encouraging the adoption of an e-filing program.

Werfel said earlier this month his agency has the legal authority to proceed with the conclusions of the report despite pushback from Republicans in the Senate Finance Committee.

“If the solution that we’re proposing is intended to help a taxpayer meet their obligation —[whether that’s] something on our website, something on an app platform, something in our phone center — I’m going to operate on the assumption that we have the authority to do it,” Werfel told reporters at the American Bar Association tax section meeting earlier this month.

“Now, if a question is raised about that authority, as I said to the Senate, I’m always open to other legal interpretations, and we need to come together and figure out whether our general assumption about our legal authority is incorrect.”

In April, Sen. Mike Crapo (R-Idaho), the top Republican on the Finance Committee, asked Werfel to acknowledge that Congress had the power to proceed with the conclusions of the direct e-file report.

“Can we agree that the decision is one that Congress can make, and not the IRS independently?” Crapo said. “I encourage you to recognize that Congress has the authority to make this determination.”

Republican and Democratic administrations have gotten behind the idea of having more direct ways to file taxes in the past.

“Since at least the 1980s, we’ve seen a lot of bipartisan interest in a free tax preparation and filing program, including a proposal in 1985 from President Ronald Reagan for a voluntary return-free system, where 50 percent of taxpayers wouldn’t even have to file a return,” said Kitty Richards, a former director of State and Local Fiscal Recovery Funds at the U.S. Department of the Treasury, during an event on Monday.

“In 2002, the Bush administration was interested in establishing ‘an easy, no-cost option’ for taxpayers to file their tax return online,” she said. “Unfortunately, by this point, the tax preparation industry had caught on to the danger that a free government tax preparation and filing process would pose to their profits.”