IRS to look into setting up free electronic tax filing system

Electronic tax filing could soon be as simple as a few clicks on a government website—free of charge.

The Internal Revenue Service will spend $15 million studying a free, government-backed tax filing system under a provision in the sweeping climate and health care law that

Congress passed this summer. It’s a landmark step toward overhauling the way most Americans file their taxes and ending years of domination of tax prep by private corporations.

Democrats have long lamented that millions of American pay for the privilege of filing taxes, and that corporate tax services take money from the neediest households. Hardly anyone uses the free e-filing options that industry supports because of restrictions on which returns qualify.

But the IRS has lacked the funding—or the clout to outmaneuver private lobbyists—to seriously consider its own e-filing platform, current and former officials say, forcing taxpayers instead to deal with a consortium of private providers and setting the agency back decades in technology and customer service.

“The IRS is completely beholden to the software companies at this point because it just doesn’t have anything to replace them,” said Nina Olson, who served as the national taxpayer advocate, the IRS’s internal consumer rights watchdog, from 2001 to 2019.

The commercial tax prep industry is gargantuan, worth $11.9 billion in 2022, according to market research firm IBIS World; 9 in 10 individual tax returns were filed digitally in 2021, the IRS reported.

The largest players, Intuit TurboTax and H&R Block, offer narrowly tailored free e-filing options, and charge $59 and $55, respectively, for their lowest-paid tiers, plus variable filing fees and costs for state tax returns.

Tax experts say a government-backed system could give more Americans access to free and trustworthy services, while increasing IRS efficiency by encouraging more taxpayers to file easy-to-process digital returns rather than cumbersome paper ones.

But that would upset an ecosystem that by many accounts has served taxpayers and the government well for decades. The U.S.’s voluntary tax compliance rate—the proportion of filers who pay federal taxes accurately each year—is 86.3 percent by the most recent measurements, among the highest of developed economies.

The U.S. tax system is complicated, and fear of making an error, experts say, can drive filers to paid services. Americans’ tax returns have also grown more complex recently with the rise of the gig economy, cryptocurrency and pandemic-related benefits programs.

“The bigger companies can throw in more bells and whistles,” said Terry Lutes, the IRS’s former director of electronic tax administration. “Their argument is that their clients want the ability to choose those bells and whistles, and they’re providing a service. I don’t think they pretend that they’re the product for everybody.”

Tim Hugo is executive director of the Free File Alliance, an industry group of online tax services that provide no-cost programs to low- and middle-income users. Hugo said that private free products save the IRS from having to build a redundant system or handle taxpayer inquiries related to e-filing.

That alliance was created in the early 2000s after the IRS struck a deal with industry—including giants Intuit TurboTax and H&R Block – that the government would not create its own platform if firms agreed not to charge the neediest taxpayers.

But that coalition—and the relationship between the IRS and industry—have frayed. Companies used the “Free File” program to advertise other paid products, seemingly with the imprimatur of the federal government.

Seventy percent of taxpayers—those making no more than $73,000 annually—were eligible for free e-filing, but firms also set their own, tighter requirements, creating a patchwork that excluded many. Some capped earnings at far less than $73,000 or set minimum income requirements. Others instituted age limits or only operated in certain states.

“Most people, it’s not like they earn significantly over the income, but if you earn a couple of thousand dollars over, you’re kicked into the freemium version,” said Rebecca Thompson, a member of the Internal Revenue Service Advisory Council, the agency’s public sounding board for customer service, and vice president of the economic equality advocacy group Prosperity Now.

Thompson works in the IRS’s volunteer tax prep clinics, whose vendor is TaxSlayer. But the firm caps its Free File income eligibility at $39,000. Frequently, Thompson said, taxpayers who exceed that income cannot file their return through the clinic without paying $29.95 for TaxSlayer’s “classic” product or finding a separate Free File provider on their own.

Representatives for TaxSlayer did not respond to a request for comment.

Taxpayers using some firms could only file for free by navigating through the IRS’s website; Free File was inaccessible on the companies’ webpages. Free File never gained the popularity federal tax officials had hoped: Fewer than 3 percent of taxpayers use the program, according to the Government Accountability Office, Congress’s nonpartisan watchdog. Intuit left the program in 2016 and H&R Block in 2015.

State regulators said that at least one company used deceptive practices to steer low-income earners toward paid products: Intuit settled with eight state attorneys general for $141 million in May after accusations that its ads for free tax prep were misleading and purposefully confused the IRS-supported Free File program with “freemium products” that begin with no charge but include fees to accomplish even modest tasks.

Under the terms of the settlement, Intuit made no admission of guilt, Kerry McLean, the company’s general counsel, said in a statement at the time.

Intuit spokeswoman Ashley McMahon said in an emailed statement that TurboTax’s free edition is “designed for those filing simple returns only (Form 1040).”

H&R Block in an emailed statement said qualifications for its free service “are dependent on how complex each individual tax situation is. If additional assistance is needed, a taxpayer can choose to connect with a tax professional via chat or online, fees may apply.”

IRS officials did not respond to a request for comment.

The industry has devoted millions of dollars over the years to defeating IRS plans to establish public filing software programs. Intuit and H&R Block have spent a combined $63.3 million in federal lobbying since 2011 on e-file and other issues.

Between April and July, H&R Block retained two lobbying firms, plus sent three in-house lobbyists to Congress at a cost of $760,000, on issues including “tax administration,” “Internal Revenue Service funding,” and “government populated returns,” according to federal disclosures.

Intuit spent $50,000 in lobbying expenses on issues including “IRS taxpayer assistance programs,” over the same period.

Now lawmakers including Sens. Elizabeth Warren (D-Mass.) and Sherrod Brown (D-Ohio), who pushed for the IRS free-file study, say they hope the funding will encourage the agency to more vigorously pursue its own platform.

Sen. Ron Wyden (D-Ore.), chair of the chamber’s Finance Committee, asked the IRS to conduct a taxpayer opinion survey on an e-file system and consult a vendor to begin to build a government-backed platform.

Those are humble steps, said Lutes, the former IRS electronic tax administration director. It will take far more than $15 million to build an e-file platform that can integrate with the rest of the IRS’s more-than-60 case-management systems, many of which are decades behind modern standards.

“Many other IRS systems would have to be modified to accommodate this,” he said. “I can’t picture a world 50 years from now that people don’t just go on to a government website and do their tax return.”