The Battle Over Free IRS E-Filing: Pros and Cons

Recently – particularly since the agency received $80 billion in additional funding as part of the Inflation Reduction Act –  the Internal Revenue Service (IRS) has been considering the implementation of a revamped free e-file tax product to simplify the tax-filing process, particularly for low-income taxpayers. 

The U.S. Government Accountability Office (GAO) notes that fewer than 3% of taxpayers use the IRS's existing free file service, which is limited in its scope and typically is not an option for those who work in the gig economy, own cryptocurrency, or have other complex tax issues. While the proposal to redevelop the current system may seem like a step in the right direction, it has ignited a fierce debate within the financial and tax preparation industries.

The Pros of Free E-File Tax Tools

Accessible Benefits For Low-Income Taxpayers

Proponents of the free e-file tax tool argue that it could greatly benefit low-income taxpayers who qualify for various financial benefits, including valuable tax credits. These individuals often rely on the tax filing system to access credits that could amount to thousands of dollars. Unfortunately, many tax preparers without formal training may miss out on these benefits, potentially costing taxpayers more than the price of professional tax preparation.

Challenging this, however, is a ProPublica report that notes “free” tax software like Intuit’s TurboTax, which sometimes charges taxpayers who have complicated returns, relies heavily on minority communities at tax time. “The fact of the matter is that the industry is targeting black and brown communities trying to stoke fear of a direct file tool,” said Brandon Tucker, senior policy director of Color of Change, a racial justice organization that supports direct file. 

“Black people are critical to their [TurboTax’s] profit margins,” he told ProPublica.

Protection From Potentially Predatory Practices

Some firms that offer free tax preparation services may even profit by selling taxpayer information, while scammers may use the guise of free services to steal taxpayer identities.

In one situation in January of this year, for example, a tax preparer was sentenced to federal prison for reporting false earnings, fraudulent charitable contributions, and ineligible tax credits to increase their clients' refunds.

At the time, Special Agent in Charge Ramsey E. Covington of IRS - Criminal Investigation's Houston Field Office urged Americans to be vigilant, "These three tax preparers not only betrayed the trust of their clients, who counted on them to prepare accurate returns, they betrayed the trust of all taxpaying Americans."

“I implore all taxpayers who plan to hire a third-party to prepare and file their tax return to choose their preparer wisely and ask questions before and during the preparation process," he continued. 

Those who support the IRS’s proposed new e-file system believe that issues like this would be largely mitigated by its existence.

The Cons of Free E-File Tax Tools

Lack of Oversight

Critics of the proposed free e-file tool raise several valid concerns. First, individuals providing low-cost tax preparation services are often not licensed or registered, potentially lacking the background checks required for tax preparers. While the system would, in theory, be designed for taxpayers to file their own taxes, it is likely that many would still use a tax preparer who would then submit a return on their behalf.This could potentially expose taxpayers to preparers who might engage in fraudulent practices.

Expertise and Evaluation

Additionally, charitable organizations advocating for free tax prep for low-income taxpayers often focus solely on the "free" aspect, failing to address the potential pitfalls. The IRS has explored the idea of preparing low-income taxpayers' returns and giving them the option to accept or reject the results, but this approach poses challenges. Taxpayers may lack the expertise to determine if the IRS's offer provides the best outcome.

Furthermore, as the AP noted in July 2023, this would require legislation – which has been proposed – to prevent the tax collector (the IRS) becoming the tax preparer, an obvious conflict of interest. 

E&O Insurance and Error Protection

Most reputable, professional tax preparers carry errors and omissions (E&O) insurance, offering taxpayers a level of error protection not available through free preparation services. For decades, companies like Intuit, the maker of TurboTax, have worked tirelessly to prevent the introduction of a free, government-funded online tax filing tool. 

Their lobbying efforts in Washington, D.C., are evident, with 63 lobbyists working this year alone to influence policymakers, per the AP’s report. At this time, it is unconfirmed if a government-backed free tax filing system would offer greater protection for taxpayers in this area.

The debate surrounding free e-file tax tools remains a contentious issue, with advocates emphasizing accessibility for low-income taxpayers and critics underscoring potential pitfalls. As the IRS continues to explore this concept, the battle over free tax filing tools is far from over, and its outcome will shape the future of tax preparation in the United States.

While both sides have valid arguments, finding a solution that balances accessibility, taxpayer protection, and fiscal responsibility remains a major challenge. The coming years will likely see continued discussions and decisions that could reshape how Americans file their taxes for decades to come.

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