In a few short months, the IRS will pilot a tax prep and filing service where taxpayers can bypass accountants and popular software and file their federal tax returns directly with the agency — for free. The IRS Direct File limited program pilot will be available to selected taxpayers in 13 states. Nationwide, several hundred taxpayers are expected to participate.
On Oct. 17, the IRS announced that the pilot will also offer state income tax filing in four of the participating states — California, Massachusetts, New York, and Arizona. (After completing their federal returns, taxpayers will have the option to be directed to a free, online companion state filing tool.)
Regarding the pilot, New York Gov. Kathy Hochul said in a release, “I am incredibly proud that New York will be one of the first states in the nation to take this bold step, and I look forward to continued collaboration with our partners at the IRS and Code for America to ensure that New Yorkers can make the most of this new tool when it launches.”
Meanwhile, tax preparation companies H&R Block and Intuit’s TurboTax oppose the IRS getting into the tax preparation business and have lobbied against the idea for years.
IRS Direct File pilot program coming soon
- The IRS is set to pilot (with limited capacity and subject to change) the Direct File system for the 2024 tax filing season. (See the report to Congress on the program.)
- Thirteen states (Alaska, Arizona, California, Florida, New Hampshire, New York, Nevada, Massachusetts, South Dakota, Tennessee, Texas, Washington, and Wyoming) will be part of the initial limited 2024 pilot.
- The agency says 70% of taxpayers surveyed expressed interest in a free IRS-provided tool to prepare and file taxes.
- IRS data reveal that people spend an average of about $250 to prepare their taxes.
“The IRS is committed to delivering significantly improved services by providing taxpayers with tools, information, and assistance to make it easier to comply with their tax filing obligations,” Commissioner Danny Werfel said in a statement. Werfel added, “Direct File — used by numerous tax jurisdictions around the world — has long been discussed as an option for improving the customer experience for taxpayers in the U.S.”
The Biden administration allocated $15 million to the IRS in the Inflation Reduction Act to evaluate the feasibility of offering a free electronic tax preparation and filing service. The total allocation of funds to the IRS from the IRA is $80 billion over ten years, but a recent debt ceiling agreement claws some of those funds back.
IRS tax prep Direct File program: What is it?
It’s important to note that this is not IRS Free File. The proposed Direct File service would be different from IRS Free File. (That system is designed for people with incomes under $73,000. But Free File is rarely used by eligible taxpayers, according to government data.)
Instead, this IRS-run tax prep and filing service would ultimately be available to a wider range of taxpayers. The agency says it would be designed to be as easy or easier to use than traditional tax prep software. But like IRS Free File, the IRS Direct File tax prep service would also be electronic and free.
In addition to considering the feasibility of a Direct File system, the IRS report focuses on taxpayer opinions and costs and contains independent analysis. According to the report, potential benefits and challenges associated with the implementation by the IRS of a Direct File program include:
- Improved experience and cost savings for some taxpayers who currently spend money to file their taxes either with accountants or using tax preparation software
- Operational challenges like having in-house technical expertise and sufficient customer service to support the Direct File system
- The IRS would also have to figure out how to coordinate with states — many taxpayers are used to filing their state and federal taxes at the same time. To that end, the IRS announced that 4 of the 13 states participating in the 2024 pilot of the program will offer state income tax filing.
Of course, there’s also a question of trust. The agency acknowledges that taxpayers may question the IRS’ motives in offering a Direct File tool. People also worry about the tool impacting IRS audits and future tax enforcement.
The IRS indicates that younger people who prepare their own tax returns might be interested in Direct File. Additionally, according to the report, taxpayers who were shown a “functioning internal prototype of Direct File, developed for research purposes, reported that the software exceeded their expectations in terms of ease of use and simplicity.”
IRS Direct file a threat to TurboTax and H&R Block?
Intuit, the maker of TurboTax, has previously indicated that a potential IRS tax prep service could pose a business threat. In SEC filings, the company reportedly wrote, “We anticipate that governmental encroachment at both the federal and state levels may present a continued competitive threat to our business for the foreseeable future.”
Intuit also recently settled a lawsuit over allegations that the company “tricked” taxpayers into paying for its tax software when they thought they were receiving a free version. However, as Kiplinger previously reported, in agreeing to the $144 million TurboTax settlement, Intuit did not admit wrongdoing. Meanwhile, H&R Block has supported proposed legislation that would have effectively banned the IRS from offering certain tax filing services.
Just before the IRS Direct File report was released in May, Intuit stock (INTU) fell to its lowest point that month, and H&R Block stock (HRB) was down 4.8%. However, since the Direct File program is still in the pilot stages, it’s hard to say whether a government-run tax prep service can compete with or harm similar services provided by those and other traditional companies.
And the cost to run Direct File will be an issue. The report indicates that an IRS tax prep service could cost between $64 million and $249 million a year, depending on how many taxpayers use it.