Will an IRS Tax Prep Service Replace H&R Block or TurboTax?

The IRS wants to pilot a tax prep and filing service where taxpayers could bypass accountants and popular software and file their federal tax returns directly with the agency — for free. Tax preparation companies H&R Block and Intuit's TurboTax, whose stocks slid before the report was released, oppose the IRS getting into the tax preparation business and have lobbied against the idea for years.

• According to a recent report to Congress, the IRS plans to pilot the Direct File system for the 2024 tax filing season.
• The agency says 70% of taxpayers surveyed expressed interest in a free IRS-provided tool to prepare and file taxes. 
• IRS data reveal that people spend an average of about $250 to prepare their taxes.

“The IRS is committed to delivering significantly improved services by providing taxpayers with tools, information, and assistance to make it easier to comply with their tax filing obligations,” Commissioner Danny Werfel said in a statement. Werfel added, “Direct File — used by numerous tax jurisdictions around the world — has long been discussed as an option for improving the customer experience for taxpayers in the U.S.”

The Biden administration allocated $15 million to the IRS in the Inflation Reduction Act for the agency to evaluate the feasibility of offering a free electronic tax preparation and filing service. The total allocation of funds to the IRS from the IRA is $80 billion over ten years, but a recent debt ceiling agreement claws some of those funds back.

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IRS Tax Prep Direct File Program: What is it? 

This is not IRS Free File: The newly proposed Direct File service would be different from IRS Free File. That system is designed for people who have incomes under $73,000 but is rarely used by eligible taxpayers, according to government data.

Instead, this IRS-run tax prep and filing service would be available to a wider range of taxpayers. It would also, the agency says, be designed to be as easy or easier to use than traditional tax prep software. But like IRS Free File, the IRS Direct File tax prep service would also be electronic and free.

In addition to considering the feasibility of a Direct File system, the IRS report
focuses on taxpayer opinions and costs and contains independent analysis. According to the report, potential benefits and challenges associated with the implementation by the IRS of a Direct File program include:

• Improved experience and cost savings for some taxpayers who currently spend money to file their taxes either with accountants or using tax preparation software. 
• Operational challenges like having in-house technical expertise and sufficient customer service to support the Direct File system. 
• The IRS would also have to figure out how to coordinate with states — many taxpayers are used to filing their state and federal taxes at the same time. 

Of course, there’s also a question of trust. The agency acknowledges that taxpayers may question the IRS’ motives in offering a Direct File tool. People also worry about the tool impacting IRS audits and future tax enforcement. 

The IRS indicates that younger people who prepare their own tax returns might be interested in Direct File. Additionally, according to the report, taxpayers who were shown a “functioning internal prototype of Direct File, developed for research purposes, reported that the software exceeded their expectations in terms of ease of use and simplicity.”

IRS Direct File a Threat to TurboTax and H&R Block?

Intuit, the maker of TurboTax, has previously indicated that a potential IRS tax prep service could pose a business threat. In SEC filings, the company reportedly wrote, “We anticipate that governmental encroachment at both the federal and state levels may present a continued competitive threat to our business for the foreseeable future.” 

Intuit also recently settled a lawsuit over allegations that the company “tricked” taxpayers into paying for its tax software when they thought they were receiving a free version. However, as Kiplinger previously reported, in agreeing to the $144 million TurboTax settlement, Intuit did not admit wrongdoing. Meanwhile, H&R Block has supported proposed legislation that would have effectively banned the IRS from offering certain tax filing services.

Before the IRS report was released, Intuit stock (INTU) fell to its lowest point this month, and H&R Block stock (HRB) was down 4.8%. However, since the Direct File program is still in the planning stages, it’s hard to say whether a government-run tax prep service can compete with, or harm, similar services provided by those and other traditional companies. And the cost to run Direct File will be an issue. The report indicates that an IRS tax prep service could cost anywhere between $64 million and $249 million a year, depending on how many taxpayers use it.