The IRS is testing free e-filing system that could compete with tax preparation giants

The Internal Revenue Service has been quietly building its own prototype system to allow Americans to file tax returns digitally and for free, according to three current and former agency officials, essentially creating government software that could disrupt the tax preparation industry.

The system was developed by the IRS and the US Digital Service, the White House’s technology consulting agency. It will be available through a pilot program to a small group of taxpayers by January, when the 2024 filing season begins, said the people briefed on the matter, who spoke on condition of anonymity to discuss internal agency conversations.

Last year’s inflation reduction bill, one of President Biden’s key legislative victories, included $15 million for the IRS to look into creating a direct filing program. The tax agency contacted the left-wing New America think tank to study the matter and produce a report, which is expected this week.

Representatives from the Ministry of Finance declined to comment on Monday.

The IRS currently refers people seeking free filing options to a consortium of companies that offer free e-filing for taxpayers below a certain income level. Although 70 percent of taxpayers qualify for these products, fewer than 3 percent of taxpayers use them, according to a report by the Government Accountability Office.

For a narrower range of taxpayers, industry giants Intuit TurboTax and H&R Block offer free products that the IRS does not officially endorse.

A free filing system offered directly by the federal government could disrupt a commercial tax preparation market estimated by research firm IBIS World to be worth $14.4 billion this year.

The system of commercial electronic filing programs has benefited taxpayers and governments on many accounts. About 9 out of 10 individual tax returns were filed digitally by 2022, the IRS reported. The US voluntary tax compliance rate – the proportion of taxpayers who pay federal taxes accurately each year – of 85.1 percent is among the highest of developed economies, according to years of research in the US and Europe.

But some experts say the private-public partnership also reflects the tax authorities’ technological deficit. Far fewer countries, including Estonia, Chile and Australia, offer government-supported digital archive services.

The Inflation Reduction Act gave the IRS $80 billion over 10 years to increase enforcement efforts for high-income earners, improve taxpayer services and modernize technology. The Biden administration said the IRS needs additional funding to catch up with sophisticated tax cheats and better serve low- and middle-income Americans who qualify for a slew of credits.

In April, when the IRS reported a spending plan to Congress for that money, Commissioner Daniel Werfel said the agency would consider a “question-based electronic service to prepare and send tax returns directly to the IRS.”

The agency plan will also allow taxpayers to request assistance from customer service representatives through secure online portals. It threatens to encroach on another area where tax preparation companies try to differentiate themselves from the IRS by using legions of accountants and other experts to service filers in premium product lines.

Industry representatives have been candid with lawmakers and administration officials about the direct-file program.

Intuit spent more than $1 million between January and March lobbying both House and Senate lawmakers on issues including “tax system integrity” and “intellectual property protection,” according to disclosures.

H&R Block spent $720,000 in the same period on lobbying for various anti-poverty tax credits, “tax administration” and “Internal Revenue Service funding,” according to its disclosure documents.

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