IRS free file figures into Senate Dems' reconciliation bill

A provision in the 755-page reconciliation bill passed by Senate Democrats last week would require the IRS to put together a report on the cost and feasibility of the agency developing and managing a system for the direct electronic filing of tax returns to replace a troubled free file program run in collaboration with industry.

The bill, named the Inflation Reduction Act, includes $80 billion for IRS enforcement, operations, tech modernization and a $15 million sliver of that supports the production of a report on the costs of a free online tax filing system. The report will include taxpayer opinions of such a system and third party input on feasibility and design, as well as the IRS’ capacity to deliver.

The IRS recently signaled that it didn't have the funding to stand up a public online tax filing system, with a top IRS official writing in response to a recommendation from the Government Accountability Office that such a system would not “significantly improve taxpayer experience.” 

Treasury Secretary Janet Yellen also pointed to funding issues in a June hearing before the Senate Finance Committee, but said that building a free file program is “definitely a priority” when pressed by Sen. Elizabeth Warren (D-Mass.) about the potential for a free file program run by the IRS. “When the IRS is adequately resourced, it’s something that will happen.”

The IRS sponsored a free file program backed by leading online filing services including TurboTax parent company Intuit that launched in 2003. However many service providers including Intuit steered free file users to paid products – as was revealed in a 2019 ProPublica investigation. This May, Intuit agreed to a $141 million settlement to resolve a probe conducted by a group of state attorneys general, with $90 payments going to more than 4 million individuals who paid for TurboTax despite qualifying for free filing under the IRS program.

Currently, Americans reporting $73,000 or less of adjusted gross income are eligible for free file, but very few of those eligible participate, according to a Government Accountability Office report from April 2022. That report also foun that the IRS isn't managing the risk of relying on the program as the main option for free online tax filing and recommended the tax agency identify more options for free online tax filing.

A memorandum of understanding governing the IRS-provider relationship expires in October, 2023. Currently, the IRS has to inform the consortium of companies in the existing free file program if it decides to field its own free file system. The GAO report recommends the IRS eliminate this requirement from future arrangements.A ban on the IRS creating its own free, online filing services originally tied into the program is gone, but companies can leave the program freely, as six have done since 2016, including Intuit.

Some Democrats have introduced legislation that would go even further than the provision in the reconciliation package.

Warren introduced a bill in July that would direct the IRS to develop free, online tax preparation and filing services, as well as a return-free process for taxpayers with simple returns using pre-filled tax returns. The bill has 22 Democratic cosponsors, and a House companion from Rep. Brad Sherman (D-Calif.) has 50 cosponsors, also all Democrats.

But there are still questions about the IRS’ capacity to develop and maintain a free, online tax return filing service, said James McTigue, a director at GAO who specializes in tax policy and administration. 

“It’s not 100% clear that the IRS could do better or as well as the private companies,” said McTigue. 

In addition to questions about the agency’s capacity to stand up IT systems and websites, there’s also customer service, something that the agency has struggled with during the pandemic, said McTigue.

“IRS is one of the most common federal agencies ordinary people interact with,” said McTigue. “Making sure people have as good of a filing experience as possible is not just a wonky issue that is only of interest to tax policy geeks. It affects the public’s perception of the entire federal government.”

The GAO report also notes that the IRS could potentially turn to the nonprofit Code for America for assistance in building a system. The nonprofit was able to stand up what is essentially a simplified filing system for people to claim their advance child tax credit payments during the pandemic relatively quickly, although an IRS system would require more functionality, like the ability to handle complex claims. The U.S. Digital Service is also an option.

The bill still has to clear the House of Representatives and get President Biden’s signature to become law. The IRS declined to comment for this story given that the legislation is pending.