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IRS submits direct filing feasibility report to Congress, 16 May 2023
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IRS moves on free, direct file tax project

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The prospects of a free, online personal tax filing service are increasingly strong after the Internal Revenue Service (IRS) revealed it could potentially roll out a prototype mechanism in 2024.

23rd May 2023
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The IRS published a direct-file feasibility report on 16 May that concluded a “substantial number of taxpayers” would benefit from cost-savings and an improved experience with such a system. The department has already created a functioning internal prototype for usability testing. 

The report said 2024 was the earliest possible delivery date, but outlined several obstacles that needed to be overcome to meet such an ambitious deadline. These challenges included product development work, customer service issues and communicating the service to taxpayers, not to mention interaction with state tax-filing mechanisms.

“Later delivery dates may come with an expectation of more functionality than would be prudent to include in an initial pilot,” the report added. In line with the IRS’s agile development approach, the likelihood is that it will go for a minimum viable option to build up to a fuller functioning product over time.

IRS e-filing options map for taxpayers

IRS graphic: Taxpayer electronic filing options
E-filing options_IRS

Technical obstacles

Joint filing with state tax returns presents the biggest technical hurdle for the project. Most leading commercial tax programs let users file federal and state tax returns together. The IRS direct file mechanism would need to let users transfer information from their federal returns to their state returns – data that is covered by strict Federal Tax Information (FTI) rules. Taxpayers using commercial products do not have those restrictions and can share their information with any party they choose. 

The direct-file system would need to be designed to give the taxpayer full control and decision-making power of the data export and import processes, the report said, leaving open the prospect of having to copy information manually from their federal return to their state return.

Wolters Kluwer reported that the IRS already has a free file fillable forms option, but relatively few taxpayers use it. Democratic representative and chairman of the House Ways and Means committee Richard Neal noted, “When 70% of taxpayers qualify for IRS’s current Free File services, yet less than 3% take advantage, it’s time for change. Today’s report provides a framework for saving taxpayers time and money while giving them the experience they deserve.”

Commercial friction

While the latest developments are not surprising, the do-it-yourself option will potentially reduce income for CPAs and tax preparers, as well as the software companies that supply them. Following the publication of the report, the stock prices of H&R Block and TurboTax owner QuickBooks both fell.

Intuit has been lobbying energetically and speaking out against the proposal for some years, and has not had a happy experience with free filing. Last year Intuit settled a $141m case initiated by New York State over misleading advertising for its “free” TurboTax offering that required taxpayers to pay to use the Premium or Deluxe versions if they wanted to submit their claims to the IRS.

Intuit admitted no wrongdoing in the action, but said it had agreed to the payment to “put this matter behind it”.

However, Brad Sills, a Bank of America analyst quoted by SeekingAlpha said that the impact of a direct-file mechanism might not be as significant as some investors think, as commercial software still gives taxpayers better capabilities to handle state taxes, import prior year data, plus an audit support guarantee and support on technical issues from the TurboTax helpdesk and online community.

International parallels

The in-house IRS approach to online personal tax filing has parallels and contrasts with what’s happening in other jurisdictions that are working on similar long-term projects to revamp tax-processing infrastructure. The IRS Modernized e-File service is the result of three decades of back-end development work and now handles 94% of the individual tax returns currently submitted through commercial tax software. Successfully integrating the direct file tool into this structure (and the state tax equivalents) without disrupting normal service is one of the risk factors identified in the IRS report. 

In the UK, HMRC (His Majesty’s Revenue and Customs) is in the middle of a 10-year “digital by default” move towards universal online filing branded Making Tax Digital (MTD).

Progress on MTD has been patchy. As a result of project shifts, the Covid pandemic and political interruptions including Brexit, individual taxpayers will be required to file online in April 2026, eight years behind the original target date of 2018. 

At the outset of MTD, HMRC promised free online filing tools, but left it to commercial developers to come forward with appropriate solutions. Software companies were not enthusiastic and grew frustrated as the project scope shifted and API definitions changed. Following the latest two-year delay last December, several “freemium” software developers have folded or been acquired as projected revenue streams disappeared. 

US tax software companies and preparers may not be happy with the IRS planning to develop its own personal-tax filing tools, but its measured assessment and methodical scoping approach suggests the US agency may have learned a few lessons from the UK MTD experience.

Article updated 24 May to include final paragraphs contrasting Direct File to the UK MTD project. Comments below reflect how practitioners view the parallel developments.

Replies (4)

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By Hugo Fair
23rd May 2023 19:47

Oh dear, and it was all sounding so (potentially) positive ... until this phrase cropped up:
"In line with the IRS’s agile development approach"!

It's bad enough in the UK where your Returns are processed piecemeal in order to feed the maws of the disjointed databases of government (resulting in most of the known system breakages aka cases of data corrupted and/or lost) ... but in an environment with so many disparate State systems, the one thing to be avoided is 'agile' (throw it at the wall and see what sticks) development.

Detailed plans (that drive specification/development/testing in parallel with communication to users of what will be in each phased release) are an almost minimum base-line.

Thank goodness my son has left the USA (and, even better, not to return to the UK)!

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By johnjenkins
24th May 2023 09:30

Great article, John. I particularly like the software houses attitude change when it appears that the savings are to the tax payer ($141m settlement for misleading advertising)

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By ireallyshouldknowthisbut
24th May 2023 09:41

interesting.
For years big software co's have forced two things in the US
(1) virtually everyone using paid software
(2) virtually everyone filing a tax return (might higher numbers than in the UK, and including those who are not even in the country any more and have nothing to report)

This seems a genuine push back on corporate interests in favour of the public following long standing campaigns.

Back in the UK we of course have HMRC's refusal to process VAT returns and forcing everyone to use paid for 3rd party software, and down the road the new tax return which I strongly suspect won't be deliverable by HMRC for unrepresented tax payers but will require paid for software. I dont think they have got that far of course, but one assumes HMRC will make their product so poor and unworkable you have to buy it in, which is broadly where they are in the US.

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Replying to ireallyshouldknowthisbut:
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By johnjenkins
24th May 2023 12:14

I think we have already begun the push back. I notice the big difference in the states is that they actually are asking the likes of us and tax payers what they think.

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