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IRS to launch its own free tax-filing service in pilot program next year

The Internal Revenue Service is rolling out its own tax-filing system in a pilot program next year, testing the feasibility of a government-run service that could cut costs for taxpayers and potentially make filing taxes easier.

The IRS announced the test run on Tuesday after it released research showing that large swaths of taxpayers support a federally-run tax prep option. Almost three- quarters of surveyed taxpayers say they are somewhat or very interested in the possibility and more than two-thirds of those who use self-prep software said they are somewhat to very likely to switch to an IRS option, the report found.

However, the full implementation and success of the e-file tax return system — called Direct File — may hinge on not just the federal government, but also the participation of state tax departments.

"Research indicates that taxpayers expect to be able to file federal, state, and local returns in one place. Any solution would require collaboration with state and local tax administrators to enable integration and avoid creating additional burden for filers," the report said. "This work would introduce additional cost and complexity to any potential Direct File option."

FILE - The exterior of the Internal Revenue Service (IRS) building in Washington, on March 22, 2013. In an effort to stop personal threats aimed at IRS employees, the agency says it will start limiting the workers’ personal identifying information on communications with taxpayers. (AP Photo/Susan Walsh, File)
The exterior of the Internal Revenue Service (IRS) building in Washington, on March 22, 2013. (AP Photo/Susan Walsh, File) (ASSOCIATED PRESS)

The Direct File pilot program is set to launch late next year to file 2024 tax returns, Laurel Blatchford, chief implementation officer of the Inflation Reduction Act at the U.S. Department of the Treasury, said during a press conference on Tuesday.

The aim of the prototype is to determine the usefulness of the IRS tax prep program by releasing it to a limited number of taxpayers. The trial group will have the option to file their taxes directly with the IRS through the prototype service online. The test run will also help the IRS to see if and how the system can be carried out nationwide.

The agency is still working through elements such as how many people would be involved in the pilot program and the overall cost. Also unknown right now is how complex of a return the prototype software can handle.

During the pilot, the IRS will continue its partnership with the Free File Alliance software companies, which provide free prep services for lower-income families.

A pedestrian walks past a H&R Block tax office in Los Angeles, California, U.S., April 26, 2017.  REUTERS/Mike Blake
A pedestrian walks past a H&R Block tax office in Los Angeles, California, U.S., April 26, 2017. REUTERS/Mike Blake (Mike Blake / reuters)

Who wants an IRS option?

The IRS used two surveys to gauge interest for the report. They found that those who self-prepare their taxes — who tend to be younger — and those who have limited English proficiency are the most interested.

For instance, 83% of taxpayers who self-prepared their return said they would be very or somewhat interested in an IRS-provided tool, versus 57% who use a paid preparer. And 81% of taxpayers with limited English proficiency are very or somewhat interested in the option, compared with 72% for the overall population.

Time and cost are big factors, too. Currently, individual taxpayers spend about eight hours and $140 preparing their taxes each year, the report said.

One of the surveys found that 37% of taxpayers would prefer a free IRS tax-filing option that provides a filled-in return. Only 15% favored an IRS option that required taxpayers to manually add information. (The remaining 48% preferred a free version of their current tax prep software.)

And when choosing between a free IRS option versus a commercial product costing $80, 70% of taxpayers went for the free service.

Various pages of the US IRS tax return forms with business tools
(Photo: Getty Creative) (Photography by Phillip Rubino via Getty Images)

The burden of the cost can fall heavily on lower-income families. Although there are free software services for families in need, they are often overwhelming and not standardized, according to Joanna Ain, associate director at nonprofit Prosperity Now.

“Having a centralized system would be really helpful for families,” Ain told Yahoo Finance. “There are so many different programs right now coming from so many different places for low-income families, which is good. But at the same time, what do I use as a low-income family? Where do I go? Who do I talk to? It's pretty complicated.”

Currently, the IRS works with third-party tax prep companies to provide a free filing system for Americans, but its reach has been limited because of income limitations and difficulty in searching for these programs online.

“Making tax filing free and easy has been on the IRS to do list for decades" Sen. Elizabeth Warren (D-Mass.) said last month during a committee hearing on the president’s budget. “The free file program currently just serves 2% of Americans [and is ] deliberately hidden from Google.”

WASHINGTON, DC - APRIL 17:  Advocates gather in Washington, DC to call out tax prep companies like Intuit TurboTax and H&R Block for blocking simplified filing and to support Internal Revenue Service (IRS) exploration of alternative free tax filing on April 17, 2023 in Washington, DC. (Photo by Tasos Katopodis/Getty Images for Economic Security Project)
Advocates gather in Washington, DC to call out tax prep companies like Intuit TurboTax and H&R Block for blocking simplified filing and to support Internal Revenue Service (IRS) exploration of alternative free tax filing on April 17, 2023 in Washington, DC. (Photo by Tasos Katopodis/Getty Images for Economic Security Project) (Tasos Katopodis via Getty Images)

Not all taxpayers were excited about a free IRS option.

The surveys found that 11% cited “I don’t think it’s the IRS’s role to prepare taxes” as their most important reason they would choose a commercial option, while 13% said “I don’t want the IRS to prepare my return” as their most important reason.

Private tax preparation companies, too, are pushing back against the IRS filing option, noting that free filing exists now.

“Today, 100% of American taxpayers can file their taxes absolutely free of charge — this is free for them and the government,” Tania Mercado, Turbotax’s corporate communicator, said. “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. A direct-to-IRS e-file system is a solution in search of a problem, and that solution will unnecessarily cost taxpayers billions of dollars.”

State taxes

Whether taxpayers get the option to file their state tax returns with the IRS prep software may play a major role in deciding if the system is feasible at a national level.

When one of the surveys in the report presented these two filing options — commercial tax software that provides both federal and state filing or a free IRS filing option that could not prepare or file state returns — 60% of taxpayers said they would remain with their commercial prep software.

One respondent in the survey said: “State taxes preparation are going to cost me money, so the IRS being free no longer offers any value.”

But the federal government could face hurdles in incorporating state returns into their system, Alex Muresianu, a policy analyst at Tax Foundation, told Yahoo Finance.

"I think that is a pretty significant challenge they might encounter," Muresianu said.

Rebecca is a reporter for Yahoo Finance and previously worked as an investment tax certified public accountant (CPA).

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