Former IRS Commissioner David Kautter, now with RSM, discusses the just lately launched report on the feasibility of an IRS-run direct file program.
This transcript has been edited for size and readability.
David D. Stewart: Welcome to the podcast. I am David Stewart, editor in chief of Tax Notes Immediately Worldwide. This week: reducing out the intermediary.
On Might 16, the IRS launched a report on the feasibility of an IRS-run free return submitting system. Whereas there have been choices to organize taxes without cost for a number of years, the Free File program was run by a bunch of tax preparation corporations. A few of these corporations had come underneath scrutiny in recent times for steering eligible taxpayers to paid companies.
So is that this new program a very good various? Right here to speak extra about that is Tax Notes senior reporter Jonathan Curry.
Jonathan, welcome again to the podcast.
Jonathan Curry: Hello once more, Dave.
David D. Stewart: So to begin off, might you inform us some background on what Free File is?
Jonathan Curry: Yeah, I might be completely happy to. The Free File program is an over-two-decades-long, public/personal partnership between the IRS and what’s known as the Free File Alliance, these corporations that you simply referred to that put together tax returns.
That began with the IRS Restructuring Reform Act of 1998, 25 years in the past. That legislation set a objective for the IRS to have 80 % of taxpayers file electronically by 2007. And the IRS determined that one of the simplest ways to do this was to enlist the assistance of the personal sector, which all sounds good on paper as a result of that frees up the IRS to do different issues. They do not have to fret about creating their very own system, sustaining it, overseeing it. They will simply type of hand that off to another person. In follow, I believe most would say it has been disappointing at finest. Some individuals have stronger phrases to say than that.
Using the Free File program peaked in 2005, and it is actually solely simply muddled alongside ever since then. This system took a nosedive after a collection of ProPublica articles again in 2019, which you alluded to earlier, that confirmed how these Free File member corporations have been deliberately steering taxpayers away from free companies and in the direction of paid merchandise as a substitute. Final 12 months, Intuit, which owns TurboTax, agreed to pay out a $141 million settlement over the claims that it scammed customers with claims of “free, free, free.”
So in follow, solely about 2 to three % of the taxpayers who’re in any other case eligible for Free File, as in that they meet these revenue limitations, are literally utilizing it. In that context, the IRS has spent the final couple months finding out whether or not it ought to throw its hat into the ring and arrange a free submitting system of its personal. They will let taxpayers file their returns immediately with the IRS as a substitute of going round by means of an middleman to file their taxes. That is generally known as direct file since you’re submitting immediately with the IRS.
This concept does have some very vocal supporters in Congress, Senator Elizabeth Warren chief amongst them, I might suppose, and Treasury Secretary Janet Yellen final 12 months at a congressional listening to stated that the IRS was going to do that, it is only a matter of timing and funding.
Quick-forward a number of months after her assertion there, the IRS will get $80 billion as a part of the Inflation Discount Act, and inside that $80 billion massive, large chunk of change, there is a small little provision that gave the IRS $15 million to check the query of what it will take for the IRS to do that.
David D. Stewart: What did the IRS should say in its report?
Jonathan Curry: Yeah, in order that report got here out [May 16] and there was loads in there about taxpayer attitudes in the direction of it. They surveyed taxpayers. In addition they developed what they name a prototype, a functioning prototype of what a direct-file system would appear to be to a taxpayer. It was restricted performance, nevertheless it led somebody to really see it, if you happen to have been to click on by means of the menus and put together your taxes that manner.
It additionally explored the professionals and cons from an administrative perspective, what it will require from the IRS, the totally different stakeholders that might be concerned, like state tax directors and issues like that. It did not actually come to any form of neat and tidy conclusion, although. It simply form of simply defined the totally different points of what could be concerned right here.
David D. Stewart: Now I perceive you latterly talked to a visitor about this. May you inform us who you talked to?
Jonathan Curry: Yeah, certain. I talked to David Kautter. He is a former performing IRS commissioner. He’s a former Treasury assistant secretary for tax coverage. Presently, he is at RSM and he is additionally a member of our board of administrators right here at Tax Analysts. And like I stated, he is a former IRS commissioner. He is somebody that might know what this may take from an inside perspective, and I believe that is a fairly worthwhile perspective to have right here.
David D. Stewart: What kind of points did you get into?
Jonathan Curry: Effectively, we began together with his impressions of the report, and I do not need to spoil an excessive amount of, you may should hear for that, however I am going to simply say upfront, he is slightly bit upset with what he noticed there. There’s quite a lot of unanswered questions in his thoughts, particularly as somebody who’d be interested by what it will take for this to really unfold.
He has quite a lot of issues over the practicality of the IRS stepping into the direct-file sport, whether or not it actually goes to be this boon to taxpayers that advocates hope for, if there is a hole between actuality and the perfect right here, and in addition a few of the obstacles the IRS goes to want to beat.
Specifically, one of many points we’re actually going to speak about loads is the problem of state tax return submitting, which you is likely to be questioning, who cares about that? We’re speaking in regards to the IRS. Effectively, taxpayers. I do not learn about you, however once I file my taxes, I file my state and federal on the identical time. And for the IRS to be doing that for you, abruptly makes this into a much bigger program than the IRS may need to get into.
David D. Stewart: Effectively, all proper, let’s go to the interview.
Jonathan Curry: I am sitting right here with former IRS Commissioner Dave Kautter, former Treasury assistant secretary for tax coverage, longtime fixture within the tax group. Dave, welcome to the podcast.
David Kautter: Thanks, Jonathan. It is good to be right here.
Jonathan Curry: Let’s leap proper in. The IRS launched its lengthy, I suppose, much-ballyhooed, long-anticipated report on the feasibility of a direct-file program. Mainly, the IRS permitting taxpayers to file immediately with them as a substitute of going by means of an middleman like TurboTax and whatnot. The report got here out final week and I am curious, did this reply each query you had about what the system may appear to be or are there a number of unanswered questions there for you?
David Kautter: The quick reply isn’t any. The report’s useful in some areas and never useful in any respect in different areas. Many questions are unanswered within the report. In reality, I might most likely say there are extra unanswered questions than there are answered questions.
However in my thoughts, the three most important unanswered questions within the report are first, which taxpayers would have the ability to use direct file and when? In different phrases, what kinds of revenue may very well be reported, will there be limits on the quantity of revenue that may very well be reported? What kinds of exercise may very well be allowable? In different phrases, on the proper kinds of exercise query, there are tens of thousands and thousands of taxpayers who’re comparatively low-income, who’re unbiased contractors, the so-called gig staff — will they be allowed to take part within the direct-file program? So the primary massive unanswered query is, who and what kinds of revenue?
Second is, what’s going to the person interface appear to be? Will it’s straightforward to grasp and use?
And third, and this can be a level which I believe is unassuming persistently within the report, is what about state tax returns? There are 43 states that impose some form of particular person revenue tax, 41 impose taxes on wages, one imposes a tax solely on curiosity and dividend revenue, one solely imposes a tax on capital positive factors. However that could be a vital query that the report acknowledges, however I believe dramatically understates the importance of.
Jonathan Curry: There was a MITRE [Corp.] examine that got here out simply earlier than this report was launched that was inspecting taxpayer attitudes in the direction of a hypothetical IRS direct-file system, and so they supplied a pair totally different situations. However one of many key takeaways was that state tax submitting, the flexibility to file your state taxes concurrently with the federal, was principally the large defining issue between whether or not individuals have been extra prone to need to change to an IRS-run system versus sticking with no matter they’ve used beforehand.
David Kautter: I believe that is precisely proper. The flexibility to solely enter knowledge as soon as is critical for taxpayers. If underneath this method that is being proposed, taxpayers had the choice to file without cost with the federal authorities immediately with the IRS, after which they needed to take the identical knowledge, go to a business software program preparation program, enter the identical knowledge in, and pay to file the state return, the attractiveness of the direct-file program goes down dramatically.
Jonathan Curry: Do you’ve got any sense of how tough it will be for the IRS to make that operate attainable, to make it a simultaneous submitting [of] state and federal?
David Kautter: What’s fascinating in regards to the report back to me is it talks about working with state directors and that is at all times essential, however I can not think about 43 states are going to develop a direct-file program for taxpayers. And so there’s going to should be an effort right here to resolve this drawback a technique or one other, or I simply do not assume the IRS direct-file program goes to be very profitable in any respect.
Jonathan Curry: My colleague, Lauren Loricchio, wrote a narrative, too, after this report got here out. She spoke with the top of the FTA — which I believe it is the Federation of Tax Directors, it is for state tax directors — and the top of that stated that they stay up for listening to from the IRS, however at this level, that collaboration has not but began, which is maybe a bit surpris[ing] provided that the report describes an effort to launch a pilot program in 2024. So maybe state submitting won’t be on faucet for not less than the preliminary pilot.
David Kautter: Precisely. There are solely two methods to get this finished that I can see, proper? The states construct direct-file applications or the IRS builds 43 applications. Each state’s tax legal guidelines are considerably totally different; some are dramatically totally different from different states. And so constructing a federal direct-file program is one factor. Constructing 43 state direct-file applications is [a] fully totally different magnitude, and the report acknowledges the significance of having the ability to file on a consolidated foundation, nevertheless it simply does not take care of it immediately. And I believe that is among the most important points, for the explanations I acknowledged earlier.
Jonathan Curry: Are you able to do me a favor and describe, in a way, the best- and worst-case situation? So that you’re principally saying, the most effective arguments for the supporters of this, the most effective arguments from critics of this. What’s the most effective factor that would come from this and what is the worst manner this might explode and crumble?
David Kautter: Certain. Effectively, let me give attention to this from a coverage perspective and administrative perspective. I believe the most effective case is the IRS builds an efficient, targeted prototype that is straightforward to make use of, safe, and common. The prototype is piloted subsequent submitting season, and the prototype is then expanded, finest case.
Worst case, IRS diverts assets from different vital know-how priorities, finally ends up with a prototype that is costly, does not work very properly, and isn’t extensively used, after which discarded. So these are the 2 extremes to me.
Jonathan Curry: Certain. OK. Honest sufficient. What do you assume it will take for one thing like this to succeed?
David Kautter: Certain. I believe there are three core parts, Jonathan. First, a user-friendly interface that is straightforward to grasp and use. Second, there needs to be high-quality, responsive customer support. Questions — regardless of how easy, regardless of how simple the software program is — there’re going to be questions. And if these questions cannot be answered, taxpayers are going to shortly abandon the system. And third, state tax return functionality, reentering knowledge and paying to file the state return whenever you’ve simply filed a federal return without cost, I believe is a big concern.
Jonathan Curry: What about a few of the sensible, or I suppose you name them operational, challenges for the IRS? We talked about the necessity to collaborate with state tax directors, however this may additionally price cash. Would the IRS must get extra funding for this? What do you form of see?
David Kautter: Certain. The funds are essential. I believe the only most essential operational impediment is mindset. Presently, the IRS doesn’t present the extent of proactive help that this form of a system would want. So in different phrases, proper now the IRS does a fairly good job of producing publications, and final 12 months did an excellent job of answering the telephone.
A direct-file system modifications the mindset. To me it is form of just like the distinction between sitting behind a money register and having clients stroll up and pay for a product, versus a gross sales consultant who has to exit and make gross sales calls and really persuade individuals to make use of the product. And so it’s this mindset which wants to alter, and also you see it not simply within the authorities or the IRS, you see it in personal trade on a regular basis. People who find themselves their entire profession, reactive, are requested to be proactive, construct one thing that folks actually need, versus one thing persons are compelled to do.
And it’s a fully totally different mindset and it provides a completely new dimension. You need to be extra proactive, it’s important to be extra customer-oriented. And I do not need to say it is the exact opposite, as a result of the IRS engages in outreach and is anxious about taxpayers understanding the tax legislation. So it is not a whole shift, nevertheless it’s a big shift.
And certain, the cash’s essential, and certain, the software program needs to be written in a user-friendly vogue, and also you want buyer help, nevertheless it’s this viewing the taxpaying public and their compliance exercise in a proactive vogue versus a reactive vogue that I believe is the largest operational impediment right here.
Jonathan Curry: It is fascinating, we have been speaking about with the prototype that they examined, they examined a practical prototype of what this may appear to be, and it was morphed so that folks might see what this appears like. They examined, I believe, with solely about 14 individuals, based on the report, however however, they examined it and so they stated the suggestions to that was really surprisingly good.
Individuals responded saying, they’re like, “Oh, this really is healthier than I anticipated the IRS would provide you with.” So it appeared prefer it might need been extra maybe user-friendly that you simply may in any other case envision a state authorities, federal company, developing with one thing.
David Kautter: It is onerous to interpret precisely what meaning. I had a good friend who used to say, “Simply because you find yourself on third base does not imply you hit a triple. You might need been born there.” And I believe in a case like this, you are worried that the bar is so low, that folks anticipated it to be such a depressing expertise, that when it wasn’t, they stated, “Effectively, that is fairly good.”
Once more, it is onerous to inform from the wording within the report, however I puzzled whether or not the bar was so modestly low that it was straightforward for the individuals who have been a part of the 14 who bought to make use of this piloted software program thought it was higher than they anticipated.
Jonathan Curry: Now, you have been speaking about how one of many benefits the personal sector has is they should exit and get individuals to need their product, whereas the IRS may simply be merely like, “This is a product, use it if you need it.”
Is the attract of free, as a result of the IRS, as I perceive, they envision this being a free service, is that going to be sufficient to get individuals to modify their return submitting supplier of selection from say, TurboTax, to the IRS?
David Kautter: I believe free will probably be sufficient for some taxpayers, nevertheless it’s onerous to inform what number of. The state return concern, I am going to convey up once more. It is an enormous concern. Despite the fact that it is free, to then flip round, should reenter the info and pay to file the state tax return, I believe will disappoint many individuals who may in any other case use the IRS direct-file.
Jonathan Curry: After which how does the difficulty of the IRS creating and working this direct-file program sit with Congress proper now? Does it match neatly inside a partisan field or is there some crossover there? The place do you form of see that?
David Kautter: Proper now I believe it is within the formative stage. It is not clear the place most members of Congress stand on this in the mean time. To date, the dialogue has taken on a partisan side to it, which isn’t wholesome if you need a free and open and full consideration of whether or not this direct-file strategy is smart. I believe the hope of turning across the early opposition that some in Congress have expressed will rely on a profitable rollout of a prototype subsequent 12 months.
I believe if the prototype goes very properly and folks really feel that the info they’re given is goal and that the person response has been favorable, that may go a good distance towards turning round a few of the resistance.
But when individuals really feel they’re being spun and so they do not feel they’ve gotten an easy story with respect to the person expertise, I believe it will get dramatically worse.
Jonathan Curry: Alongside these traces, Commissioner [Daniel] Werfel has been within the sizzling seat really currently after it was revealed within the report that the IRS was already creating a pilot program to check this out or to strive it out in 2024. The view is that the IRS ought to have waited for the outcomes of this report, debated it in Congress, waited for some form of authorizing, “Go forth and do that,” fairly than plunging forward.
You are a former IRS commissioner, so that you’re properly suited to know what it is like to sit down in that seat. I hate to make you be the backseat driver to a present commissioner, however I’m curious to know, do you assume this might need been a misstep, might have been dealt with in a different way?
David Kautter: Effectively, I believe it’s totally unlucky that the administration moved ahead in the way in which that it has. I believe direct submitting with the IRS is a matter that deserves full and open consideration if it will have any probability of bipartisan help.
As a substitute, the method adopted to this point, particularly constructing and modeling a prototype and planning to launch a direct-file program subsequent 12 months earlier than the report was ever finalized and delivered, has the looks that the examine was perfunctory, that the surveys and the stories have been irrelevant to the choice to maneuver ahead, and that the federal authorities wasted $15 million on a report that was irrelevant to the decision-making course of.
It is unclear to me who drove this course of, however in my expertise, this isn’t how the IRS tends to function. So my guess is that this course of was pushed elsewhere within the administration, however I do not need firsthand information of how this course of—
Jonathan Curry: You are not at the moment within the commissioner’s seat.
David Kautter: I’m not.
Jonathan Curry: OK, understood. Effectively, let’s discuss prices. The examine was $15 million for this. The report says the estimated price of creating and working this, the annual price is between $64 million and about $250 million per 12 months, relying on a complete vary of things. And even that wide-ranging estimate is topic to vital uncertainty based on the report.
Additionally in Washington, everybody likes to speak about price in 10-year increments, [so] $64 million or $250 million turns into $640 million to a $2.5 million price ticket in our typical mind-set about the price of issues. First query on that, does that price ticket appear practical?
David Kautter: I believe the best understatement in your complete report is its assertion about “appreciable uncertainty” across the improvement price. At one level in my profession, I used to be liable for the tax know-how funds of a Large 4 accounting agency. Expertise tells me that it’s nearly inconceivable to anticipate all the issues concerned in a undertaking of this magnitude.
I believe the prices are considerably understated for not less than three causes. First, the IRS has no expertise on this space. Second, the IRS does not have the capability to construct one thing like this proper now. So this initiative goes to require the IRS to rent individuals with the proper expertise or outsource the event or a mixture of the 2. And third is the difficulty we have talked about earlier on this podcast, which is the state tax functionality.
I do not know the way IRS proposes to resolve that drawback, however when the report says there’s appreciable uncertainty, I might say that is understated dramatically.
Jonathan Curry: The worth tag estimate that we talked about, the $64 million and $250 million, relies off an estimate the place, once more, most likely appreciable uncertainty, however they discuss servicing about between 5 million and 25 million taxpayers.
The Free File program, the Free File Alliance, the place the personal sector is meant to be offering free return preparation for low-income taxpayers, solely had about 4 million customers for tax 12 months 2020. What does one thing like this do to the tax preparation trade? Is that this the apocalyptic finish of TurboTax, Intuit, and all of the above?
David Kautter: Effectively, I believe personal trade goes to be simply wonderful on this space, particularly within the quick time period. And the explanations I say which are, model loyalty is a compelling motivation for a lot of customers, together with with respect to tax software program. There’s a sure consolation that comes with utilizing the identical software program 12 months after 12 months. You develop into conversant in it, you develop into comfy with the questions. Third, I might say ease of already having final 12 months’s knowledge in a system makes life less complicated. You may examine final 12 months to this 12 months.
Issues in regards to the IRS being the preparer, reviewer, and the enforcer are going to discourage some taxpayers from utilizing this system. And I believe some will use the IRS software program, I am certain of that, however I do not assume the tax preparation software program trade has a lot to fret about, particularly within the quick time period.
Jonathan Curry: And once more, I’ll use this metaphor, I am beating it to demise right here. You wore the commissioner’s hat for a time, you’ve got been within the workplace there. Do you assume the IRS desires to be doing this? Now to some extent, maybe it does not matter what they need to do, they do what they’re advised to do by Congress, Treasury, and so forth. However inside the constructing, is there a form of eagerness to go on this route?
David Kautter: I do not know the place the present commissioner and administration stand on this in the mean time, however I might say the IRS has an extended checklist of know-how priorities. In 2019, they issued a modernization report which listed dozens and dozens of applications that they wanted to enhance or develop with a purpose to serve taxpayers successfully.
It’s onerous to imagine that abruptly, direct file has catapulted from not on that checklist in any respect, to No. 1 on the checklist. So I believe that the IRS has finished a very good job of figuring out what it must do to enhance person expertise with the IRS.
It is within the means of making an attempt to construct a few of that software program with the infusion of money from the Inflation Discount Act. They’ve the funds to perform that, however direct file was not one thing once I was within the performing commissioner job that was excessive on our checklist.
The business software program distributors have good merchandise, they work properly. Knowledge bought into the system successfully, the IRS had an efficient working partnership with these software program distributors. And so IRS was inclined, not less than once I was there, to give attention to areas [which] wanted help, the place you can considerably enhance the taxpayer expertise, and this was not considered one of them.
It appears to me partly, that is being pushed by a need to assist taxpayers lower your expenses by having the ability to file. And there’s something irrational a couple of tax system the place the federal authorities desires you to file electronically and will not let you file immediately with them electronically, the place it’s important to undergo a software program vendor.
So I perceive the arguments and I perceive the irrationality of it. I simply have a tough time believing that that is prime of the profession of us’ checklist on the IRS with regards to know-how initiatives.
Jonathan Curry: And I believe the IRS report itself, in addition to the unbiased analysis included within the IRS’s report by New America and their exterior individuals serving to them out with that, they each got here to the conclusion that if that is to succeed, it will require management, IRS management, to essentially decide to this. I believe you talked about this earlier, a half-hearted try and similar to, “This is a direct-file factor. You should utilize it if you need.” It is not going to get off the bottom properly.
David Kautter: That is going to take a sustained, targeted effort to persuade taxpayers to make use of the brand new software program, the direct-file system. As you identified, Jonathan, earlier, we have a Free File system now the place taxpayers can file without cost their federal return.
There are round 70 million taxpayers who’re eligible for Free File and about 3 % of these taxpayers use that system. Why a dramatic variety of taxpayers, in extra of the three %, would abruptly resolve to make use of a direct-file system that the IRS has provide you with as a substitute of the business software program that is obtainable without cost, shouldn’t be clear to me.
So I believe the one manner this turns into widespread is the system is straightforward to make use of. There’s loads of buyer help. The IRS advocates actively that taxpayers can profit from utilizing this method, that it’s without cost. And I believe that is the one probability this method has of prospering going ahead. And I can not assist however point out, once more, you have to clear up the state tax return drawback, I believe, or this can at all times be only a shadow of what it might probably be.
Jonathan Curry: All proper. Effectively, Dave, thanks a lot for being right here. It has been a pleasure speaking with you about Free File.
David Kautter: Jonathan, thanks for inviting me. It is an fascinating matter and it will be fascinating see to see the way it evolves.