Tax Preparation Firms, Lawmakers Brace for IRS E-File Report

Lawmakers and tax prep companies are bracing for a report due within days that could be the first step toward creating an IRS-run free electronic tax filing system.

That’s the hope of Democrats like Sen. Elizabeth Warren (D-Mass.), who backs such a system and calls it long overdue. Republicans say such a setup raises taxpayer privacy concerns and fear government overreach.

The Biden administration’s tax-and-climate law directs the IRS to submit to Congress a report within nine months of the law’s passage—a deadline that arrives Tuesday—on a “free direct e-file tax return system” that includes a cost analysis, survey results about taxpayers’ opinion, and the opinions of an independent third party.

The IRS tasked the think tank New America and Loyola Law School professor Ariel Jurow Kleiman with providing the independent analysis required for the report; the law gave the agency $15 million to conduct the entire study, though the IRS has said it is not paying New America and Jurow Kleiman.

Warren said Wednesday she expected a briefing on the report in the coming days that adds context to the topic, which has received renewed attention in recent years following increased scrutiny of the existing Free File partnership with tax-prep companies. The industry has been lobbying against such an agency-run system.

Warren said she hopes the IRS would move forward on implementation with a pilot project if the report comes out in favor of such a system.

Republicans are far more skeptical.

“What we’re concerned about is, is it being designed in a way where it truly has a level of neutrality,” said Rep. David Schweikert (R-Ariz.), a member of the Ways and Means Committee, reflecting GOP concerns that making the tax collector the tax preparer could create new conflicts and privacy concerns. Republicans have also raised concerns about the impartiality of the experts involved in the study.

Schweikert pointed to the current Free File partnership—where the IRS partners with tax-prep companies for the companies to offer free software to low-and-middle income taxpayers— suggesting private sector tax preparers would want to get a taxpayer the best deal.

“In a weird way that software is my advocate,” he said. “If you’re a taxpayer using a government system, are they your advocate?”

In an interview with Bloomberg Tax earlier this month, IRS Commissioner Danny Werfel said he wants to make sure the IRS has a solid grasp on the pros and cons of creating a direct e-file system.

“What I’m interested in is making sure that we have a good understanding of what those diverse viewpoints are, that we’re communicating the calculus and the evidence base for any decision, go or no-go, that comes out,“ he said.

Roots of the Debate

Warren and other progressives have for years introduced legislation to direct the IRS to create a free online tax-prep service, arguing that such a system would simplify tax filing and prevent taxpayers from needing to pay private companies for preparation services. That push intensified after ProPublica in 2019 wrote a series of articles finding that tax-prep companies took steps to downplay their free options under the existing Free File partnership between the companies and the IRS.

New York Attorney General Letitia James (D) announced earlier this month that about 4.4 million TurboTax customers who paid for tax services for their 2016, 2017 and 2018 tax returns but were eligible for the Free File program will be receiving checks in May as part of a $141 million settlement with Intuit. The company did not admit wrongdoing as part of the agreement.

TurboTax and H&R Block have stopped participating in the Free File program in the last few years, and participation in the program is under 10% of eligible taxpayers.

Tax-prep companies have mounted a vigorous, multi-year lobbying effort opposing an IRS-run free tax filing system. They argue that not only are there already free options for filing, but also that an IRS-run free tax filing system would be a conflict of interest.

Stephen Ryan, general counsel of a coalition of tax-prep companies called the American Coalition for Taxpayer Rights, said in a statement that “a direct efile system is unnecessary, costly and will divert attention and resources from more pressing priorities at IRS.”

The coalition laid out its concerns in a March letter to New America, arguing that the IRS already faces many burdens and that there are significant data security risks.

Republicans also doubt the IRS is even allowed to implement a direct e-file system.

“They don’t have the statutory authority to be able to create a free filing system,” said Sen. James Lankford (R-Okla.). “They have statutory authority through the IRA to study it.”

Werfel told reporters earlier this month that he operates on the assumption that the IRS has the authority to work on solutions that allow taxpayers to meet their obligations, but that he’s happy to have a dialogue with lawmakers about their questions.

“Once the report is issued in mid-May, I think there’ll be an opportunity to engage on a whole host of different questions about direct file and the program,” he said. “And I would assume if there are questions from either the Senate or other stakeholders about legal authority we’ll engage at that time.”

State Tax Returns

A survey conducted in December by MITRE Corporation, which wasn’t commissioned by the IRS, found that for simple tax returns 48% of taxpayers would use their current software, 15% would use a direct e-file system, and 37% preferred a system where the IRS prepared and filed returns for taxpayers using information from their employers. The percentage that would use their current software rises to 60% if the IRS-run options don’t include state tax returns.

In the case of complex tax returns, 70% of taxpayers would choose direct e-file and 30% would choose their current software, though the percentage that would use the IRS-run option would fall to 59% if that option did not allow people to also use it to file their state returns.

Skeptics and supporters of an IRS-run filing system say the issue of state tax returns is important.

National Taxpayers Union President Pete Sepp, who has raised concerns about an IRS-run system, said “creating an online function that allows seamless filing between both levels is a much bigger matter, and frankly a much more expensive one to try and address.”

Former National Taxpayer Advocate Nina Olson, who is supportive of an IRS direct e-file option, said that when she was interviewed by New America, the issue of state tax administration came up.

“I think that will be reflected in their report,” said Olson, now executive director of the Center for Taxpayer Rights. She added that perhaps the IRS could initially do pilots with states that already have sophisticated e-filing systems and roll out coordination with states in stages.