Can the IRS Beat the Tax Prep Industry at Its Own Game?

The free Direct File program is being tested in 13 states this tax season.

by

Earlier this week, the IRS announced that beginning in the upcoming tax season, 13 states would pilot a free, electronic tax filing system known as Direct File. Years in the making, the development of such a system has faced aggressive counter campaigns from the largest tax preparation companies and their trade associations. According to the money-in-politics watchdog group OpenSecrets, the tax prep industry spent $90 million in lobbying over a two-decade period.

There’s a lot at stake for the tax prep industry if taxpayers have an easily available, free option on the table. Even as 70 percent of taxpayers are eligible for the existing Free File program (more on that later), only 3 percent use it, translating to taxpayers spending up to $13 billion each year on tax prep services, according to estimates from the personal finance company NerdWallet.

In response to the new Direct File, the pro-industry argument touts the existing Free File program as sufficient. Created in 2001, Free File is a public-private partnership between the IRS and companies from the sector known as the Free File Alliance. For the tax prep industry providing the free filing service, in return, the IRS pledged not to create an in-house tax filing system.

More from Jarod Facundo

But two decades of severe underutilization and companies such as Intuit deliberately writing code to shadow-ban the Free File option from search engine results, the IRS today is recognizing the misaligned incentives from the Free File program’s inception. Why would the tax prep industry unilaterally hand over its market share—the customer base that sustains its business operations—to the federal government for free? Instead, Free File as operated for the last 20 years was simply a fig leaf for an industry that continued to funnel its customers into paid options.

Outside of the federal government, in the weeks leading up to the Direct File program’s announcement, more than 200 advocacy groups under the banner of Better IRS mounted a digital campaign drumming up support for the pilot program. Throughout the process, Better IRS directly responded to the tax preparation and financial services trade association, American Coalition for Taxpayer Rights (ACTR), which earlier criticized Democratic lawmakers Sen. Elizabeth Warren (D-MA) and Rep. Katie Porter (D-CA) over their support for a Direct File program.

In short, ACTR argued that the existing Free File program could be improved, taxpayers won’t know how to use a new Direct File, administrative costs would add up over the upcoming decade, and public support for Direct File isn’t there. It also mentioned a potential legal challenge against the IRS for engaging in tax preparation.

Better IRS counters that the American Coalition for Taxpayer Rights arguments are at best speculative, and at worst distorting the intended implementation of Direct File. This first version is a pilot program; future iterations would hopefully improve from there. Some of the complaints ring distinctly hollow—if public support is minimal, then why would the tax prep industry care? One suspects that tax preparers are actually worried that people might love Direct File.

Common sense would indicate that the public response to Direct File will entirely turn on whether it works or not.

Indeed, Better IRS cites the IRS Report to Congress on a Direct File system that 72 percent of Americans are interested in a Direct File program. To be fair, this figure was disputed by a report published by the Treasury Inspector General for Tax Administration (TIGTA) auditing the IRS Direct File study. The report indicated that the IRS’s survey design could have translated to inflated support for a Direct File program, further adding that the agency didn’t provide documentation to support the program’s expected adoption rate and operating costs.

In response, the IRS argued that the agency had acknowledged the possibility of overstated support, and that the agency provided documents for cost estimates even if TIGTA found them insufficient. Oddly, the IRS response did not mention the adoption rate concerns.

Common sense would indicate that the public response to Direct File will entirely turn on whether it works or not. If the IRS can demonstrate a high adoption and satisfaction rate with taxpayers participating in the Direct File program in the pilot states, then people will flock to it. It will be a challenge given that most taxpayers are accustomed to H&R Block, TurboTax, and other services. But if Direct File is similarly simple and also free, presumably most will prefer it.

Aside from the customer satisfaction perspective with a Direct File experience, legal challenges questioning the agency’s authority could perhaps be the program’s biggest threat in the medium to long term. ACTR questioning the IRS’s authority over tax preparation should be seen not as an empty threat, but rather a promise to file a lawsuit designed to roll back the creation of Direct File, with the legal “justification” to be filled in later.

But until then, the tax prep industry’s front-end PR campaign is losing steam from a combination of missteps. Because the Speaker-less Republican-led House chaos has no end in sight, the news of the Direct File pilot program went unmentioned by the GOP this past week. Further, without a Speaker in place, the GOP war against the IRS and its $80 billion in funding from the Inflation Reduction Act is on hold.

In the event Republicans resolve their intraparty squabbles before the current continuing resolution expires on November 17, they’ll be facing a two-fronted battle: attacking the Direct File program and clawing back funding. It’s hard to imagine the GOP setting those as priorities and executing them in a matter of weeks.

The only backstop Republicans currently have is the 1 percent budget cut from former Speaker Kevin McCarthy (R-CA) and President Biden’s debt ceiling deal. The impact of that 1 percent cut in the legislation’s text translates to a $1.4 billion cut to the IRS, but could rise to as high as $21.4 billion, according to the Prospect’s reporting from earlier this year. (Those losses could be replenished, however.)

All told, despite legitimate concerns from the tax agency’s inspector general, the shift to a Direct File program has riled the middlemen with the most to lose from a government-sponsored tax filing alternative. At the same time, the party hell-bent on slashing the agency’s funding is stuck in the mud until further notice. For the IRS, that’s a good sign.

A second Trump administration will cement a right-wing majority on the Supreme Court for a generation, and put our collective future in the hands of someone who will be virtually unchecked by our institutions. The country has shifted rightward, and the reverberations will ensue for potentially the next few decades. In this climate, a robust independent media ecosystem will be more important than ever. We're committed to bringing you the latest news on how Trump's agenda will actually affect the American people, shining a light on the stories corporate media overlooks and keeping the public informed about how power really works in this country.

Quality journalism is expensive to produce, and we don't have corporate backers to rely on to fund what we do. Everything we do is thanks to our incredible community of readers, who chip in a few dollars at a time to make our work possible. Any amount you give today will help us continue reporting on what matters to our democracy.

You can help power this newsroom by making a one-time donation or by becoming a member today.