Among the many provisions of 2022’s Inflation Reduction Act, one provides new funds specifically designed to improve the Internal Revenue Service’s (IRS’s) services and technology to make tax filing easier for Americans.
One major initiative coming out of the law’s passage is the Direct File program: The tax agency’s internal effort to build its own free tax filing software for Americans to use for federal tax returns. The pilot version of the program launches in 12 states this year, largely to people with simple tax filing situations as a test of the concept. If successful, the program may scale to more states and complex tax circumstances, effectively firing a shot across the bow at for-profit tax preparation companies like Intuit’s TurboTax and H&R Block.
If you’re not familiar with the IRS Direct File program and how it works, read on to learn the basics. We cover how to participate, who qualifies, what it might mean for companies like TurboTax, and more.
What Is the Direct File Program?
Starting in 2024, the IRS will implement a free online tax filing service for many American taxpayers to use if they’re residents of 12 states, including Arizona, California, Massachusetts, and New York.
This new program, called “Direct File,” will offer a similar experience to what millions of Americans encounter every year with third-party tax preparation software. Focused on providing a user-friendly experience, the IRS describes the experience as “[following] a step-by-step checklist that guides you through the filing process and you can easily see your progress. When you finish, Direct File shows you a clear summary of your 2023 federal taxes from the information you entered. When you submit your return, Direct File will send email confirmation of the submission, and another email when the IRS accepts your return for processing.”
In fact, Direct File will follow the same interview-based, question and answer format used by most commercial tax software products. Instead of logging into an independent company’s portal to prepare your return, you’ll login directly to the IRS’s website to prepare your return.
Related: Federal Tax Brackets and Rates
Direct File vs. Free File
Direct File marks a departure from an existing tax filing assistance program offered through the IRS. For twenty years, the IRS has provided free access to for-profit companies’ electronic filing software if you were a low- to moderate-income taxpayer through their Free File program.
However, the IRS Free File program never entailed the IRS internally developing and maintaining tax preparation software. It also limited the range of availability by income level. Although the IRS had previously been urged to develop its own software for everyone to use, it always passed on this opportunity. The cost of developing and maintaining such a comprehensive program seemed too high, especially when numerous private and publicly traded companies offered suitable options for taxpayers.
But this all changed with passage of the Inflation Reduction Act in 2022. The legislation authorized additional funding to conduct a feasibility study of what offering a free, direct filing tax software program would entail. Funding was also made available to launch a “limited-scope pilot” with taxpayers in certain states to prepare and file their federal returns in 2024 directly with the agency—for free.
Related: Do You Have to File Taxes This Year?
Who Can Participate in the 2024 Direct File Program?
The Direct File pilot program debuts this year for taxpayers in 12 states: Arizona, California, Florida, Massachusetts, New Hampshire, New York, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. Residents of these states will be presented with the option to file their federal returns electronically in 2024 directly with the IRS at no cost.
Residents of Arizona, California, Massachusetts, and New York won’t be able to file their state tax returns through the Direct File program (the eight other states don’t have a state income tax). However, the program will guide users in these states to state-supported software that can be used to file their state return. People in Washington state will also be directed to a state website where they can apply for the state’s working families tax credit. The other states participating in the pilot program don’t have an income tax.
To participate, you’ll need to have a relatively simple tax situation, meaning limited types and amounts of income, deductions, and credits to claim on your return. These are meant to test the program before identifying additional avenues for expansion later, should the program prove successful.
What Is a “Simple Tax Return?”
As noted earlier, eligible taxpayers will need a simple tax situation for their individual federal tax returns to participate in this year’s pilot program. Per the IRS, the following types of income, credits, and deductions will be available in the if you live in a pilot state:
- Wage income reported on Form W-2
- Social Security benefits reported on Form SSA-1099
- Railroad retirement income reported on Form RRB-1099
- Unemployment compensation reported on Form 1099-G
- Interest income of $1,500 or less reported on Form 1099-INT
The pilot is not an option if you:
- Have other types of income, such as gig economy or business income
- Itemize deductions
- Claim other credits like the Child and Dependent Care Credit, Saver’s Credit, or the Premium Tax Credit
This “limited-scope pilot” approach allows for a controlled rollout, ensuring that the system can handle real-world scenarios before a nationwide launch. By targeting taxpayers with simple tax situations, the IRS is addressing a segment that often faces challenges with existing tax software, which can be overwhelming for those with basic filing needs on a federal return.
Should the IRS Develop Its Own Tax Software?
The Inflation Reduction Act charged the IRS with surveying taxpayers on their “opinions, expectations, and level of trust” with an IRS-run Direct File system. The IRS’s 2022 Taxpayer Experience Survey (TES) included additional survey questions to fulfill this requirement and had supplemental information gathered from a survey conducted in conjunction from the MITRE Corporation. Among several items measured by the two surveys, one set of questions directly addressed what taxpayers thought the role was for the IRS.
The MITRE survey indicated a large share of taxpayers reporting the view that tax filing assistance is a proper role for the IRS, with 46% expressing interest in an IRS-provided tool. Their primary reason for stating this preference? Preferring to give their financial information directly to the IRS instead of a third party. Illustrating this opinion, one respondent to the survey wrote, “If the government is requiring me to file, they should offer a free service.”
Not everyone agrees, with a full 11% saying the IRS isn’t the correct party to prepare returns for taxpayers. More than a third expressed a preference for using a commercial product.
Still more taxpayers hadn’t previously considered the possibility of the IRS providing a Direct File option. As one interviewed taxpayer said in a user research session, “I don’t know why I never really thought about them doing it, so I didn’t even look into it, but it makes sense that they would. So I would definitely, I would consider using it. It just didn’t occur to me before.”
The opinions collected during the survey show a broad range of opinions, but a large number of taxpayers indicate that a government-run system for preparing and filing taxes is appropriate.
Pros of the Government Developing Its Own Tax Software
If the IRS moves forward and develops a full tax prep software system for all taxpayers, here are some of the expected features and perceived advantages:
- Forms sent to the IRS would automatically be entered for you. The IRS receives tax forms each year through the normal course of tax season (e.g., W-2 and 1099 forms). Information from these forms would be pre-entered into the tax software, reducing both time and errors when preparing your returns. Conceivably, your return could be automatically filed once the IRS confirms the information it has received about you.
- Cost savings for taxpayers. By having a free solution from the federal government, taxpayers could save money that they would otherwise spend to purchasing commercial software.
- More options for taxpayers. Since there’s no effort to ban the use of commercial tax software products, having an IRS-run program gives taxpayers another choice in how to complete their tax returns.
- Enhanced security and privacy. By not having to divulge personal information to a third-party software company, you reduce the risk of your information falling into the wrong hands or being used for the wrong purposes.
- Potential reduction of errors. If the IRS pre-populates details of your return based on forms they receive from your employer, vendors, or other parties, it could reduce the number of errors on your return.
Cons of the Government Developing Its Own Tax Software
On the other hand, here are some of the disadvantages of the IRS developing a fully-functional tax software program:
- Conflict of interest. Some people think there’s a conflict of interest if the IRS is involved in both tax preparation and tax collection.
- Drain on IRS resources. The cost of building and maintaining a comprehensive tax software program will divert IRS resources from more important things.
- Less choice for taxpayers. If a government-run solution is broadly adopted, this could lead to a lack of competition and less diversified user experiences and interfaces (not every person has the same tastes and preferences).
- Loss of private-sector jobs. If the IRS offers a comprehensive tax preparation program for free, it might cause commercial solutions to shutter, thus leading to a loss of private-sector jobs.
- Public perception and trust. Some taxpayers might distrust a government-provided service for preparing their taxes, preferring independent third-party providers instead.
- Commercial software might still be needed for state and local returns. Despite the IRS potentially offering a federal tax return software solution, taxpayers may still need to purchase software to assist with their state and local taxes.
What Does Direct File Mean for Companies Like TurboTax and H&R Block?
As anyone who’s ever done their own taxes can attest, filing taxes can be time-consuming, difficult, and often costly. Congress, and by extension the IRS, recognized this and pushed forward an effort to provide taxpayers with tools, information, and assistance to make it easier to comply with their tax filing obligations.
And based on the IRS’s 2022 TES, the majority of Americans were either “very interested” (28%) or “somewhat interested” (45%) in using a free IRS-provided online tool to prepare and file their taxes. Survey results assessing the likelihood of taxpayers who currently use an existing self-preparation tax software switching to this public tool echo a similar message: 24% and 44% say they would be “very likely” or “somewhat likely” to switch, respectively.
That’s bad news for commercial tax prep software providers like TurboTax and H&R Block. Introducing the Direct File service marks a significant shift in the landscape of tax filing. The potential to reshape how millions of taxpayers do their taxes could disrupt the multi-billion-dollar commercial tax preparation industry—a system that has resisted such change for decades. Existing tax software providers would lose customers and, ultimately, could be put out of business.
Whether this comes to fruition or the Direct File program merely serves a narrower set of filers is yet to be determined. However, what the new IRS pilot program certainly represents is the federal government’s first attempt to launch a competitive product in the tax preparation space.
Obviously, surveys don’t always accurately reflect the opinions of all Americans across the country. And the 2022 TES in particular also comes with some controversy of its own. According to a report from the Treasury Inspector General for Tax Administration addressing the survey, “taxpayer interest in a Direct File tool may be overstated due to the design of the surveys conducted.”
Again, no survey is perfect. But the 2022 TES certainly showed that many taxpayers are interested in the Direct File program, which most likely isn’t being discounted by TurboTax, H&R Block, and the commercial tax software providers currently in the marketplace.