The IRS recently announced a pilot initiative for its Direct File program set to roll out to 13 states for the 2024 tax season.
The program is being presented as a mobile-friendly, interview-based online service that aims to simplify the filing process while reducing associated costs. Additionally, it should allow many taxpayers to avoid the minefield of for-profit tax preparation software.
If tax prep giants want to remain relevant, they need to provide value-add services—reviewing calculations for accuracy, automating error-checking, providing audit defense services, resolving disputes, and assisting with complex tax situations not supported by Direct File.
The for-profit tax industry isn’t happy about the IRS’s pilot program and doesn’t plan to go quietly. But instead of lobbying against the inevitable, it should try to provide technology-driven enhancements to the free filing option.
Embrace AI
Finding a way to operate symbiotically with the government program is the obvious path forward. For-profit tax prep software can do this by using artificial intelligence and machine learning to automate mundane tasks, such as aggregation of income records for filers that aren’t relying on employer withholding, as well as automated error-checking, and tailored guidance based on individual circumstances.
Rather than attempt to halt Direct File’s progress, TurboTax and its contemporaries have the potential to design and deploy robust AI-powered platforms that check Direct File calculations for accuracy and optimize the process for users.
The advent and availability of large language models could enable taxpayers to interact with the Direct File system in other ways, such as through a ChatGPT-style conversational interface—or even connect directly with banking software to automate the process of reporting taxpayers not subject to employer withholding, such as independent contractors.
For-profit tax prep companies should insist that Direct File provide application programming interfaces that allow third parties to build services on top of the IRS program—while keeping taxpayer data safe.
With a sanctioned hook into the IRS program, an AI application could significantly bolster audit defense services. AI can offer a proactive approach to defense by systematically analyzing tax returns for potential audit triggers and advising on preventive measures—catching problems before they arise.
In the realm of dispute resolution, AI can play a role in gathering necessary documentation by guiding taxpayers through the dispute process, and perhaps even predicting likely outcomes based on historical data and the relevant law.
Complementary Ecosystem
The relationship between Direct File and third-party platforms has potential to foster an ecosystem that caters to the diverse needs of the taxpaying public. At the highest level, third-party platforms can offer a suite of specialized services that Direct File may not have the capacity to handle at launch.
For instance, the first iteration of Direct File won’t handle filing of state returns. A third-party application will still be necessary, and there will presumably remain niche needs—such as multi-state filing and international tax considerations—for which private solutions will remain in demand.
These specialized services cater to niche taxpayer needs, filling in gaps and adding layers of utility that a one-size-fits-all government program may not provide.
Accessibility and cost-effectiveness are Direct File’s biggest benefits. Meanwhile, sanctioned technology-driven enhancements can enable the public program to benefit from the private sector’s ability to quickly adapt to emerging technologies—versus a large-scale government initiative that may take years to fully implement.
Companies such as Intuit don’t need to look at Direct File as a zero-sum game. By adopting a collaborative approach, both the IRS and private tax preparation entities can contribute to a more enriched, efficient, and accessible tax filing ecosystem.
The for-profit tax software industry should redirect its considerable largesse and political sway toward demanding the IRS to enable third-party integrations rather than trying to stop Direct File in its tracks. Ultimately, Direct File can benefit from insights garnered from the use of authorized third-party platforms by funneling those back into the program, leading to improvements in the initiative itself.
Evolution
Direct File will symbolize an important step in democratizing tax filing in the coming years, aligning with global standards when most of the industrialized world already offers streamlined tax services. It presents an opportunity for the IRS to modernize its tax infrastructure, fostering a culture of inclusivity and transparency in tax preparation that needn’t be limited to taxpayers.
Collaborating with private sector innovators while maintaining the underlying preparation engine as a separate public service can promote a tax ecosystem that reduces predatory preparation practices but which is still conducive to innovation. For example, Direct File could permit third-party providers to offer services such as automated legal advice for issues including back taxes and divorce-related tax implications to generate interest in the private sector.
The for-profit tax preparation industry has long held a dominant position in the market—one that has been guarded through lobbying and, according to some, so-called “dark patterns” aimed to trick customers into paying for services that should be free.
Ultimately, the Direct File program is a call for this industry to evolve. It necessitates a reimagining of value proposition to align with taxpayers’ evolving needs and expectations. But it remains an open question whether these companies are up to the challenge.
Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social.
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