Future of IRS Direct File Hinges on Pilot Results, Politics

The new free IRS-run online tax-filing system is on trial this filing season in more ways than one.

The results of the agency’s pilot—which faces opposition from the tax-prep industry and Republicans but is being cheered by Democrats—will give the IRS fuel to decide the experiment’s future.

With weeks left in the filing season, stakeholders want to know if the system known as Direct File is here to stay. Next steps will depend on how the IRS measures early results, but even with a successful pilot the fate of the project is not shielded from the outcome of the upcoming presidential and congressional elections.

“The IRS is not at all insulated from politics and this was one of our fears when we were thinking about the long term feasibility of the program,” said Loyola Law School Professor Ariel Jurow Kleiman, who served on a third-party task force to evaluate the feasibility of the IRS running such a system.

Democrats’ 2022 law known as the Inflation Reduction Act set aside $15 million for the IRS to report on the feasibility of creating a direct e-filing tax return system, and subsequently Treasury leadership directed the IRS to create the pilot.

As of this week, millions of taxpayers in 12 states with simple tax situations can submit their returns directly to the federal government at no cost and avoid paying big fees for tax preparation. The IRS expanded the tool widely Tuesday.

It isn’t an all-out offensive against the tax preparation industry, at least not yet. Agency officials underscore that the IRS is an ally and alternative to the tax preparation industry, though the sector has lobbied against the creation of a government system for over a decade.

“The IRS has an obligation in making it as easy as possible for taxpayers to meet their filing requirements and that includes giving taxpayers options for how they file their return,” Bridget Roberts, IRS chief of Direct File, said in an interview for Bloomberg Tax’s “Talking Tax” podcast.

The agency has a relatively small team for a product as complicated as Direct File, Roberts said. It’s a combined effort with the US Digital Serviceand contractors, totaling over 100 people.

Political and Private Pressure

Republicans and industry have argued the effort is unnecessary and creates a conflict of interest.

Taxpayers and lawmakers should take a hard, skeptical look at the pilot and when they do “they will conclude that this costly pilot is completely unnecessary given the multitude of free options available today,” said David Ransom, counsel at the American Coalition for Taxpayer Rights, a group of tax-prep companies. He also echoed concerns about IRS transparency with the cost, a critical metric for assessing the project.

Tax-prep giant Intuit said in a statement that use of Direct File could lead to people overpaying their taxes. The company has faced its share of criticism, including claims it misled users into thinking the services are free.

The priorities of the next president and Congress will determine if the IRS has the funding to implement Direct File. Republicans have chipped away at the agency’s supplemental funding from the Inflation Reduction Act, and if likely Republican nominee Donald Trump becomes president again, he could direct that Direct File be reexamined or killed. On the other hand, many Democrats have long wanted the IRS to create free agency-run filing software and will seek to continue Direct File.

The more transparent the IRS can be, the better, Jay McTigue, director of the Government Accountability Office’s Strategic Issues team said, adding that it builds confidence with Congress and the broader tax community to publicly share data that supports the agency’s ultimate decision.

Measuring Success

The Direct File pilot is limited in size and scope to follow best practices for new technology. That also means the IRS won’t be able to rely on the numbers of users alone to show interest and success, making the sell to stakeholders on the pilot’s future less black and white.

The IRS expects of the 19 million possible eligible taxpayers, about 100,000 will use Direct File this year. Currently, about 15,000 taxpayers have created an account, started a return, or completed a return using Direct File.

“Success is not hitting a specific number,” but rather meeting the user’s needs, Jason Miller, the Deputy Director for Management at the Office of Management and Budget, said in an interview with Bloomberg Tax.

The IRS has teased the pilot’s early success but has been closed-lipped on critical details like cost, which will be dependent on how many taxpayers use the tool. The agency has committed to sharing results and a public dialogue at the end of filing season.

Academics, agency officials, product professionals, and tax professionals said they’d like to see the IRS to measure the cost, if taxpayers are able to finish their returns, how the agency handled the workload, barriers to entry, how it integrated with states, and data security.

In the short term, a successful technical product is one that is “functioning well, that isn’t embarrassing,” Jacob Goldin, a tax law professor at the University of Chicago, said.

“It doesn’t look like software that was created in 1997. It doesn’t have a healthcare.gov problem,” Goldin added, referencing the disastrous launch of the Affordable Care Act website. Healthcare.gov serves as a cautionary tale of a government rollout and is used as a point of reference by IRS officials as what the agency should avoid.

Ayushi Roy, the Deputy Director of New America’s New Practice Lab and co-author of the IRS Direct File Third-Party Report, said she wants to see how transparent the IRS is about what they are learning from the pilot and how the IRS is incorporating feedback and iterating the product.

It will likely take the IRS at least three years before it can properly evaluate the program, said Terry Lutes. He was the IRS’s former director of electronic tax administration in the early 2000s during a contentious time between the companies and the agency.