Direct File Passes Trial

May 31, 2024 | Comprehensive Taxes, Individual Taxes, Taxes, Update | By


Update 782 — Direct File Passes Trial
IRS Offers Taxpayers Streamlined DIY

How did you prepare and file your tax returns this year? Did you spend hours doing paperwork, trying to figure out which deductions you qualify for? Did you give the paperwork to a tax preparation firm that filed on your behalf for a fee? Or were you one of the lucky few able to file directly with the IRS using a program that cut the prep time to under an hour while claiming basic deductions… for free?

This year, the IRS launched Direct File, a pilot program available in 12 states that helped 140,000 filers save time and money. Meanwhile, Democrats in Congress wrote the IRS, FTC, Treasury, and DOJ yesterday asking for an investigation into tax preparation firms’ practice of pressuring filers to allow disclosure of private information for marketing purposes. Below, we describe the program, the user experience, and ways the IRS might expand the pilot to make it available to more filers for the 2024 tax filing year. 

Best, 

Dana

The Internal Revenue Service (IRS) rolled out a pilot for Direct File – a free program that allowed taxpayers with simple returns to file their taxes directly with the IRS – during the 2024 filing season. Taxpayers in the 12 states included in the pilot gave Direct File great reviews, with 90 percent of users rating their experience positively and 86 percent saying it increased their trust in the IRS. 

Now, IRS Commissioner Danny Werfel and Treasury Secretary Janet Yellen are tasked with deciding the fate of Direct File, a decision that we can expect in the coming weeks. We believe that Direct File should be expanded to a wider slate of states and tax situations following broadly positive user sentiment and given the potential for the tool to eliminate tax filing costs averaging $150 per taxpayer, reduce time spent preparing returns, and reduce the number of low- and middle-income eligible non-claimants for valuable tax credits. 

IRA Funding Expands Access to Free E-file Tax Returns

The Inflation Reduction Act (IRA) provided a significant investment of $80 billion to the IRS. Among the IRS-related provisions in the IRA, an appropriation of $15 million was paired with a directive for the IRS to explore and report on “an IRS-run free, direct electronic filing (e-filing) tax return system,” otherwise known as Direct File. The purpose of this tool was to address the complexity and cost associated with filing tax returns, as well as to limit paper filing which is much more cumbersome to the IRS and taxpayers. 

The IRS delivered the report on Direct File to Congress in May of last year after studying the option and decided – with support from the Biden administration – to proceed with a limited pilot program for the 2023 tax year (2024 filing season) based on a 72 percent taxpayer interest in the tool and an assessment that the government agency was “technically capable” of doing so. 

This decision received pushback from anti-IRS Republicans and the powerful tax preparation lobby, with some questioning the IRS’s authority in establishing such a tool in the first place and others noting concerns of redundancy given the 20-plus year existence of free filing services in conjunction with private companies, otherwise known as the Free File Alliance. While Free File does allow taxpayers to file returns for free and was extended today by the IRS through 2029, the program has been rife with problems as Intuit (a member of the Free File Alliance) settled a $141 million lawsuit brought on for using deceptive advertising to direct Free File users to paid systems. 

Though this opposition is expected to continue, the IRS has continuously stressed that “the Direct File pilot is just another option for filing your taxes. No one is required to use Direct File, and it does not replace any of the existing options for filing.” 

Pilot Program’s Scope and Design

This year’s Direct File pilot was available for taxpayers in 12 states, a majority of which do not have state-level income taxes (state integration was key to ensuring taxpayers could complete all of their returns using Direct File. Four of the states had integrated systems that allowed free filing of state returns and eight were states with no state income tax, as indicated below): 

  • Arizona 
  • California (state income tax)
  • Florida 
  • Massachusetts (state income tax)
  • New Hampshire 
  • New York (state income tax)
  • Nevada 
  • South Dakota 
  • Tennessee 
  • Texas 
  • Washington (no state income tax, but has an online application for state EITC)
  • Wyoming

The pilot was also intentionally limited to taxpayers with relatively simple returns, according to best practices with new technology. It was made available to filers in the 12 pilot states listed above who:

  • “Report income earned from jobs that generate a Form W-2; including taxpayers with more than one job with W-2 wages;
  • Claim Earned Income Tax Credit, Child Tax Credit, and the Credit for Other Dependents;
  • Claim the standard deduction and deductions for educator expenses and student loan interest;
  • Lived in the same state for the entire calendar year 2023”;
  • Received Social Security income (SSA-1099), unemployment income (1099-G), or interest income of $1,500 or less (1099-INT).

The initial stages of the Direct File pilot began in February 2024 with availability to some state and federal employees. The pilot was then expanded in short availability windows for more taxpayers as the IRS gradually increased the allotment of available spaces. Direct File was made available to all eligible taxpayers in the 12 pilot states around a month before the April 15 filing deadline. 

Subscription Rates and Response to Pilot

The IRS set a goal of 100,000 users of the Direct File pilot during the 2024 filing season. While ensuring large numbers of filers was never the main directive for the pilot, this goal was exceeded as more than 140,000 returns were filed using the Direct File tool and many more taxpayers engaged with the pilot to assess their eligibility: 

Source: IRS

Usage was far below the 19 million taxpayers estimated to be eligible for the Direct File pilot, though this should not cause reason for alarm. The pilot was intentionally restricted to ensure that kinks could be ironed out before moving towards expanded access, a lesson taken from past software rollout flops like Healthcare.gov. Usage was ultimately in line with IRS expectations and exceeded what was necessary to provide sufficient data to evaluate the pilot. 

Direct File also received a massive uptake in users as access was scaled up throughout the 2024 filing season and more taxpayers became aware of their eligibility, showing promise for future widespread demand for and use of a less restricted version of the tool: 

Direct File’s Growth Outpaces Filing Season Trends

Source: IRS

The most significant results of the Direct File pilot program were related to the user experience. According to IRS Commissioner Danny Werfel, Direct File users “filed their taxes in less than 30 minutes using Direct File and praised it as an easy, no-cost tax filing experience.” This statement is consistent with a survey of over 11,000 users, as a remarkable 90 percent of respondents rated their experience with Direct File as “excellent” or “above average” and only two percent rated their experience as “below average” or “very poor”:

Source: IRS

Notably, the Direct File pilot also helped to improve taxpayer opinions about the IRS, with 86 percent of surveyed users saying their experience with Direct File increased their trust in the government agency. 

The Case for Direct File Expansion; Priorities to Consider

The 140,803 returns filed with Direct File this past tax season saved taxpayers an estimated $5.6 million and hundreds of thousands of hours. However, this is a fraction of what the program could accomplish if expanded to a larger slate of taxpayers. 

According to the Economic Security Project, Direct File has the potential to save “Americans a total of $11 billion annually between filing fees and time costs.” The same report projects that expansion could lead to the claiming of $12 billion in low-income tax credits by removing barriers to preparing and submitting returns and improving the efficacy and effect of powerful anti-poverty efforts like the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC). On average, investment in Direct File is expected to have a high rate of return for taxpayers with every dollar invested generating $106 per filer due to savings on professional tax preparation services and additional claiming of credits. 

Based on the Direct File pilot’s resounding success and the potential upside of a scaled-up Direct File tool, 20/20 Vision (in conjunction with the Coalition for Free and Fair Filing) recommends the following priorities when considering expansion:

  • Direct File must quickly expand to more states. Though the ultimate success of this effort will depend on the willingness of states to establish a state tax filing system consistent with Direct File, many state and federal officials have expressed the desire to bring the tool to their constituencies. 
  • Direct File must expand to cover more tax situations that apply to a greater swath of low- and middle-income Americans. It is important that families who can least afford to pay private preparers and most need the support they access through the tax code are prioritized throughout Direct File’s expansion. Continuing to engage families in the design and development of Direct File will help keep the product focused on those who need it most. 
  • Direct File should further streamline the tax filing process. Taxpayers struggle every year to collect their tax documents and provide data the IRS already has on file — and as the Direct File report indicated last year, some taxpayers expect that an IRS-provided filing tool would pre-populate their tax data. Secretary Yellen stated earlier this year it would be “very natural” to build on the product and add pre-population to Direct File. Direct File already took its first steps into pre-population during this year’s pilot, beginning with prior-year Adjusted Gross Income (AGI). 

The bottom line is that Direct File is extremely popular among users of the tool during this year’s pilot and taxpayers in general. This month, over 250 organizations, including 20/20 Vision, signed a letter urging the IRS and Department of Treasury to expand the program. 138 members of Congress joined this effort by signing a similar letter expressing support on behalf of their constituents, some grateful for participating in this year’s pilot and others eager to bring Direct File to their state. 

The success of the Direct File pilot, widespread support for expansion, positive cost-benefit analysis for the government, and potential upside for the taxpayer give little reason not to scale up the program next filing season. The IRS and the Department of Treasury are likely to release a more detailed plan forward for the program in the coming weeks, and the tool could very well be accessible in your state as soon as next year.

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