When it comes to filing federal and state tax returns in the U.S., even the former head of one of the companies that makes big bucks off of tax season thinks things could be simpler.
“The U.S. tax system is a remarkable abnormality. It is so, so complex,” says Bill Harris, the former CEO of PayPal and TurboTax parent company Intuit. “We could have a radical reformation of the tax laws in this country. We should.”
He’s rooting for the success of the IRS’s new direct filing software, which will enable many taxpayers to file their taxes online—for free. It’s in a pilot phase now, and an early look the agency provided to the media suggests it’s a relatively simple online form that’s significantly more user-friendly than, say, filing a paper return. And at no cost, it has the potential to give the TurboTaxes of the world a run for their money.
Many Americans have long called for a government-run alternative to private tax preparation software. But those advocating for a federal substitute shouldn’t celebrate the development just yet: The IRS is likely still years away, at least, from an effective tool that can handle more than the simplest tax situations and help most Americans pay less to file their tax returns.
Most taxpayers cannot use the current direct file tool; the IRS is inviting select filers to use it in an initial testing phase now before making it more widely available in 12 pilot states in March: Arizona, California, Florida, Massachusetts, Nevada, New Hampshire, New York, South Dakota, Tennessee, Texas, Washington, and Wyoming. People in those states interested in using it can sign up to be notified when it’s available.
Courtesy of the U.S. Treasury Department
There are other limitations. This year, the tool can only support W-2 income, meaning gig economy workers and others with 1099 income cannot use it. Those with capital gains income, insurance through statewide marketplaces, who itemize deductions, have income over $200,000, or have taken a retirement account distribution also cannot use it this year. It does support the child tax credit (CTC) and earned income tax credit, and the IRS said it could easily be updated if Congress expands the CTC as it’s currently debating.
It also requires users to input their own information, instead of pre-populating fields with a taxpayer’s W-2 information—the IRS already has this information from employers—which increases the likelihood of errors. Depending on the success of the pilot, the IRS said it will add more functionality to the tool and make it more widely available in future tax seasons.
Despite its current limitations, the IRS’s direct file tool still could help tens of millions of Americans file simple returns for free.
“This is now, and will probably always be, limited to people with very simple tax returns. And that’s a great thing, that’s what [the IRS] should be doing,” says Harris. “They should be making it as easy as possible for those people.”
An ‘existential threat’ to the tax prep industry
Many other large, wealthy countries already have a tax-filing option similar to what the IRS is now piloting, says Chad Cummings, a certified public accountant and tax professional. Those nations also provide taxpayers with a pre-filled tax form.
“Needless to say, this process greatly simplifies the filing of tax returns for most taxpayers,” says Cummings.
Though there have been some calls to institute a similar system in the U.S., the reality is that each year many Americans must pay a tax professional or pay for software to do it themselves (the IRS offers a free file system for certain taxpayers through third-party software companies, but the options are difficult for many individuals to navigate). Some of that is because of the sheer complexity of the U.S. tax code; there are countless credits, deductions, and other considerations for some taxpayers.
And then there’s the third-party tax preparation industry itself. Reporting has shown TurboTax, H&R Block, and other preparers spend millions of dollars each year lobbying Congress and the IRS to discourage simplifying the system by, for example, implementing a direct file program or providing pre-filled forms.
“It is not shocking that these companies will continue doing all that is in their power to discourage the use of a direct file mechanism, as it represents an existential threat to their business model,” says Cummings. “This is a developing topic and could potentially have multibillion-dollar impacts on the tax preparation industry and countless jobs.”
I just received a demo of the upcoming IRS Direct File tool. The IRS has built an impressive product that will give taxpayers a secure option to file their taxes online for free. This pilot program will start small in 2024, to allow the IRS to test it and learn from taxpayers. pic.twitter.com/1BvmMCcEdD
— Secretary Janet Yellen (@SecYellen) January 19, 2024
Harris says the complexity of the U.S. tax code means there will always be a place for TurboTax and other paid preparers. Until Congress simplifies things, he says, some people—high-net worth individuals, business owners, investors, etc.—still will pay to file their taxes to maximize their returns.
But for the vast majority of Americans, IRS software that streamlines the filing process can’t come soon enough.
“If they do it well,” says Harris, “it will be a great service for people.”