The new Direct File program is the Biden administration’s big gamble to shake up this practice by establishing a free competitor to behemoths like Intuit’s TurboTax and H&R Block.
But Direct File, which uses a question-and-answer format much like those paid websites, is a far cry from what some proponents of free tax software have sought. It doesn’t draw from the IRS’s vast trove of financial information on each taxpayer, including W-2 wage statements. Some had envisioned that a government platform would offer pre-filled returns to save users time and effort.
A 2022 study whose co-authors included Treasury and Federal Reserve economists underscored the potential for such a platform, concluding that the IRS has enough information to correctly tally about 45 percent of tax returns without any input from the taxpayers themselves.
Economist William Gale, director of the Tax Policy Center at the Brookings Institution, says many countries already have some form of pre-filled returns. “This is not some flying car technology that only exists in people’s minds,” Gale said.
An underlying challenge is political and industry opposition. Republicans would probably oppose any expansion of the IRS’s authority, including Direct File, which is currently billed as a one-year pilot program. Commercial tax prep companies would lobby against it as well, as the industry has lobbied against other tax simplification efforts.
While some lawmakers such as Sen. Elizabeth Warren (D-Mass.) have long pushed for an IRS free-filing website, Congress never authorized Direct File. Instead, Democrats included a provision in the 2022 Inflation Reduction Act to allocate $15 million to study whether taxpayers might want a government filing option, and whether the government could create it.
The IRS spent some of those funds on the study, which it submitted to Congress in May. It then spent the rest, supplemented by other parts of its budget, to build the platform, which it describes as essentially part of the study.
That workaround has drawn the ire of Republicans, including House Ways and Means Committee Chair Jason T. Smith (R-Mo.). “The Biden administration’s so-called ‘study’ into establishing a direct e-file system was a foregone conclusion designed to further their goal of inserting the IRS into every aspect of Americans’ lives,” he said in a statement.
Republican attorneys general from 12 states sent a letter to Treasury Secretary Janet L. Yellen last week arguing that the IRS should not have been allowed to create the site without Congress’s direction and urging her to end the program. In addition to questioning the program’s legality, they raised the issue of paid preparers who might lose business.
“Millions of Americans work with small businesses in our states to file their taxes at an affordable cost, including both independent tax preparation services and local accountants,” they wrote. “The Direct File program needlessly threatens the livelihood of thousands of these small businesses tax preparers.”
In its report to Congress, the tax agency forecast that a government-built site would cost $64 million (for about 5 million users) to $249 million (for about 25 million users) per year to run, largely due to customer service costs. Last month, however, IRS Commissioner Danny Werfel said it would be “premature” to tally the total cost of building the site, noting that the IRS also relied on workers from other agencies, including the General Services Administration and the U.S. Digital Service, on the project.
A U.S. Digital Service official, speaking on the condition of anonymity to discuss the website before its debut, said the team kept growing from the day they started coding in May, reaching about 100 government employees and contractors now working on the software.
Cost concerns have been raised even internally. An IRS advisory committee cautioned against creating a proprietary tax platform as recently as June. Instead, it said, it would be more efficient for the IRS to prioritize publicizing its existing and underused “Free File” option — a separate offering in which commercial tax prep companies provide free services to low- and middle-income taxpayers. Only about 3 percent of eligible taxpayers use Free File, in part because the companies divert many users from the free version to a paid option.
Tim Hugo, who runs the Free File Alliance that provides the commercial software, said he was “perplexed” that the IRS would build its own site. “When you have a program here that’s free, that’s been up and running for 21 years — that costs the IRS nothing. And yet you’re going to spend huge sums on Direct File.”
Many advocates, however, say they don’t think the existing Free File program can be greatly improved and are eager to promote Direct File as a new option. The tax software companies “had their chance for years to actually provide Americans with a credible way of filing their taxes for free [with Free File], and they have failed,” said Igor Volsky, executive director of the advocacy group Groundwork Action. His organization will buy ads to promote Direct File in the states where it will debut.
In its first iteration, Direct File will become available in 12 states, covering more than 40 percent of U.S. taxpayers. But many taxpayers in those states will be ineligible: for example, the roughly 1 in 5 households with a self-employed worker, or the 1 in 10 taxpayers who itemize. Few will be excluded based on income — the program allows individuals with wages up to $200,000, or couples up to $250,000 — but others might not qualify if they bought health insurance on the government marketplace, purchased cryptocurrency or claimed certain credits like those for child care.
IRS officials say they expect hundreds of thousands of taxpayers using the new Direct File website, a tiny fraction of the more than 140 million households that file tax returns.
In January presentations to journalists, agency officials showed a map of every question that the site might have to ask a taxpayer, totaling more than 1,000 data points. Expanding to cover more tax situations would mean enlarging that map. Pre-filling taxpayers’ information would be another sort of challenge.
Davidson Gillette, an East Carolina University professor who has researched other countries’ pre-filled returns, said he views the largest hurdle to be the American practice of joint filing, which makes it harder for the government to know who owes how much. “It’s unclear if the IRS would be capable of bearing that additional burden … with the level of funding they have,” he said.
One lesson may be California’s program almost 20 years ago, when it sent pre-filled returns to some households. Critics of Direct File point to that experiment as a cautionary tale — nearly 80 percent of the taxpayers who got the pre-filled return chose not to use it, and fierce opposition from the tax prep industry scuttled the effort.
The project was led by Joseph Bankman, the Stanford tax law professor who is now better known as the father of disgraced cryptocurrency mogul Sam Bankman-Fried. Despite the experiment’s response rate, he still backs the idea on a national scale.
“The thing that would be valuable to almost all taxpayers would be if they didn’t have to keep track of their W-2s or 1099s,” Bankman told The Washington Post. But Direct File doesn’t do that, he pointed out: “If all you’re doing is giving people an alternative to TurboTax, a lot of people are going to say, ‘I’ll stick with TurboTax.’”
