Budget and tech challenges loom over IRS's direct file pilot

After two decades of relying on a private-public partnership with tax prep companies to give most Americans a free option to file their tax returns online, the IRS announced plans to pilot its own, digital direct file tool during the 2024 filing season earlier this month.

The news came with a congressionally mandated report on the feasibility of such a system assembled by a cross-functional team of IRS employees. The U.S. Digital Service also helped the IRS build an internal prototype of a mobile-friendly filing tool for usability testing.

The forthcoming pilot is a test, not a commitment to field a new program, IRS Commissioner Danny Werfel told reporters.

But if the IRS does decide to launch such a tool, it will need to overcome tech, operational, and funding challenges — the potential contours of which came into sharper relief over the weekend. The White House and House Speaker Kevin McCarthy, R-Calif., released a debt limit compromise bill that would rescind $1.38 billion and repurpose a quarter of the $80 billion given to the IRS over the decade in the Inflation Reduction Act, according to the White House. It still needs to pass Congress to become law. 

A White House official tried to tamp down concerns about the near-term impact of the funding rollback, noting that the agency's funding boost under the Inflation Reduction Act is good for 10 years and could be revisited under future legislation.

"So we don’t think it’ll fundamentally change what the IRS does over the course of the next few years," the official told reporters on the call on Sunday evening. 

The tax agency already has a Free File program with tax prep companies that offer free services to eligible taxpayers. But although around 70% of Americans are eligible, the majority use other means to file their taxes, which they might have to pay for. Werfel said that the program agreement goes through 2025.

An Intuit spokesperson and an H&R Block spokesperson both told Nextgov/FCW separately that the pilot is a “solution in search of a problem” when asked for comment. Both left the Free File program in recent years.

“Today, 100% of American taxpayers can file their taxes absolutely free of charge — this is free for them and the government. An IRS direct-to-e-file system is redundant and will not be free — not free to build, not free to operate and not free for taxpayers,” the Intuit spokesperson said.

If the pilot were to turn into a permanent option, that would put the IRS in step with other nations, according to Nina Olson, the former National Taxpayer Advocate and current executive director of the Center for Taxpayer Rights.

“Tax administrations around the world in the smallest countries possible are doing this. The IRS is an outlier,” Olson told Nextgov/FCW. “Filing taxes is something that is inherently governmental.”

One impact of a direct filing tool run by the IRS could be how people file their taxes. 

Taxes account for 71% of the federal government’s “paperwork burden” every year. On average, individuals spend about 8 hours and $140 on filing taxes annually, according to the IRS report, which says that 72% of respondents surveyed said they would be interested in using an IRS tool.

“The IRS is thinking about a fundamentally different model with respect to how tax administration works,” said Natasha Sarin, a former counselor to Treasury Secretary Janet Yellen and deputy assistant secretary for economic policy in the Treasury Department — now an associate professor of law at Yale Law School ― during a fireside chat at a recent summit held by nonprofit Code for America.

“They are thinking about accuracy on both sides of the ledger,” Sarin said. “Making sure you get access to the benefits and credits that you are entitled to in the same way that we make sure those at the top of the distribution today are paying their fair share, too,” she continued, calling the IRS the “largest administrator of federal benefits in the government.”

Still, to build and maintain a tool, the IRS would need consistent funding over time, experts say.

The IRS study, which estimates the costs of the tool to be between $64 million to $249 million depending on its scale and use, warns that it would need continuous improvements over time, and “without adequate funding for each release, the system would be at risk of rapidly becoming obsolete.”

“The whole point of having a 10-year, multi-year stream of money for the IRS was to give them the certainty they needed to actually be able to make multi-year, transformative investments,” Sarin told Nextgov/FCW in mid-May. “Those of us who are big advocates of transforming tax administration need to be super focused on communicating what the certainty of funding means going forward.”

The direct file tool’s potential relationship with state taxes presents another looming challenge. 

Taxpayers expect to be able to file state and federal taxes together, as an independent analysis section by New America and tax expert Ariel Jurow Kleiman included in the IRS report notes. 

Tracey Patterson, chief program officer at nonprofit Code for America said that “trying to solve for both the federal and 50 states at the same time is not reasonable.”

But “for an individual household, the refund that you can get to maximize your tax credits would be the combined state and federal taxes,” so it will be important to take a “truly human-centered approach, which is getting people all they can in terms of the tax credits that they have earned,” she said.

“There are a range of questions here for the IRS to consider, including paramount security of taxpayer data and requirements of 6103 taxpayer privacy protection,” Sarin said, referencing the law that limits disclosures of return information. “This will be an area of focus. You could imagine states working to develop systems that can plug into the IRS ecosystem.”

Ayushi Roy, formerly of 18F and the Technology Modernization Fund, and currently the deputy director of New America's New Practice Lab, said that the IRS will also have to “test a lot of internal operations and the internal workflows that would allow for the future product to be successful.”

That includes an agile software development process with user experience research and cross-functional collaboration.

The analysis from New America and Kleiman also pointed to the need for customer support, noting that the agency currently has “outdated call center infrastructure” and a call center staff not trained to answer tech-related questions.

The project puts the IRS — and how people experience its services — in the spotlight. The stakes? 

“Whether it can rebuild a reputation for serving the public that has taken a battering over the last decade when it’s been starved of resources,” said Donald Moynihan, chair of the McCourt School of Public Policy at Georgetown and expert on administrative burdens and government reform.