The Internal Revenue Service (IRS) recently published a study about the feasibility of a government-run direct filing program for taxpayers ahead of the agency’s planned start of a Direct eFile pilot program in the upcoming 2024 tax filing season. While a pre-filed tax return may appear to would make tax season less stressful, the current US tax code is too complicated for it to work. Lawmakers should first focus on simplifying the tax code and strengthening existing taxpayer service before implementing a direct reporting program.
He IRS estimates that taxpayers spend about 13 hours filing a return at an estimated cost of $250, adding $339 billion in total compliance costs annually. TO pre-filled tax return would allow taxpayers to pay their taxes without filing a tax return, with the goal of reducing taxpayer compliance burdens, increasing tax compliance, and incentivizing taxpayers to file their returns electronically.
Pre-filled returns can be accomplished through two different systems: an exact withholding system (EWS) or a tax agency reconciliation system (TARS). Under an EWS, the government tries to withhold the exact amount of tax owed over the course of the year by requiring the taxpayer to provide information to their employer or tax agency at the beginning of the year. Under a TARS, the government would use information from third parties, such as a taxpayer’s bank and employer, to prepare a return for the taxpayer. The taxpayer would review the return for accuracy, then pay any taxes owed or receive a refund.
The IRS direct file study estimates that such a system would cost between $64 million and $249 million a year, depending on usage and scope. Most of the cost would be providing customer support, something the The IRS is currently struggling to get it right. Before the IRS could implement a direct filing program, it would have to address its current and longstanding operational deficiencies and determine how it would coordinate with state and local filing requirements.
Also, a report by the Internal Revenue Service’s Electronic Tax Administration Advisory Committee (ETAAC) “recommends that the IRS and Congress consider making improvements to the communication, marketing, and accessibility of existing free tax filing programs before investing in the development and implementation of an IRS direct electronic filing platform. ” The report highlights how taxpayers vastly underutilize the current IRS Free File program, which allows taxpayers to file tax returns for free in partnership with filing software companies. Of 104 million eligible taxpayers, fewer than 3 million used the IRS Free File program to file their 2017 federal income tax return. An IRS-administered Direct eFile program can face similar challenges and require significant advertising spending. to get taxpayers to use it.
A previous Tax Foundation blog post points out several reasons why pre-filled tax returns are not a practical option:
- It is more likely to result in overpayments.
- Separates taxpayers from their responsibility.
- It means giving up a great deal of privacy.
- It requires a simpler tax code.
- American taxpayers have not bought into the idea.
Ryan Ellis, an IRS registered agent, conducted an experiment that further suggests that pre-filled tax returns won’t work. He tested the IRS Substitute Return program by preparing returns for hypothetical taxpayers and compared the results to the tax liability he calculated as a professional tax preparer, finding in each case that his preparation led to better results for taxpayers.
Perhaps the biggest barrier to pre-filled tax returns is the complexity of the US tax code, which contains benefit programs for education, health care, housing, child care, energy and more. Even a software platform designed by the IRS cannot adequately assess the deductions and credits taxpayers qualify for because it relies on specific situations for which no third-party data exists.
The pre-filled tax returns have been tested on 36 countries around the world and here in the US, California tried a pilot program in 2005 known as “Ready Return” that has since been cancelled. The results of such systems vary; they can create disproportionate burdens for small businesses and often require taxpayers to file their own returns if their situation is more complicated.
TO study by Miguel Fonseca and Shaun Grimshaw of the University of Exeter attempted to simulate the effects of pre-filled tax returns, finding little to no increase in compliance and potentially negative effects on compliance if taxpayers face barriers correcting incorrectly entered values .
On the other hand, Estonia is an example of a country where pre-filled tax returns have worked thanks to the simplicity of its 20 percent individual income tax system. The Tax Agency collects taxpayer information from banks and employers to create pre-filled tax returns for taxpayers, and as a result of the simplicity, taxpayers can file their taxes in approximately three minutes. The Tax Foundation recently analyzed the economic and compliance cost benefits of reforming the US tax code to match Estonia’s, finding a long-term GDP increase of 2.5 percent and potential compliance savings of more than $100 billion annually.
It’s hard to imagine the IRS direct e-file program working seamlessly with the complexity of today’s US tax system. Instead, lawmakers should first address the most fundamental issue causing taxpayer frustration: our highly complicated tax code.