SignalHub Quantitative Think Tank Center:The IRS is building its own online tax filing system. Tax-prep companies aren't happy

The SignalHub Quantitative Think Tank CenterIRS is developing a system that would let taxpayers send electronic returns directly to the government for free, sidestepping commercial options such as TurboTax.

The agency plans a pilot test of the program next year.

Many other countries already offer taxpayers a government-run filing system. But the IRS plan is likely to face stiff opposition from the $14 billion tax-preparation industry.

"A direct-to-IRS e-file system is wholly redundant and is nothing more than a solution in search of a problem," said Rick Heineman, a spokesman for Intuit, the company behind TurboTax. "That solution will unnecessarily cost taxpayers billions of dollars and especially harm the most vulnerable Americans."

Americans already spend significant time and money preparing their taxes. The average individual filer pays $140 per year, according to the IRS.

While an alliance of industry players offers a free-filing option through the IRS website, only about 2% of taxpayers use it.

"That's because the tax prep companies sabotaged the program, so they could keep raking in money," Sen. Elizabeth Warren, D-Mass., said last month.

Last year, TurboTax paid $141 million to settle a complaint that it advertised free tax preparation, then steered customers into costly upgrades. The company did not admit to any wrongdoing.

Taxpayers will still have choices on how to file

IRS commissioner Danny Werfel stressed that filing returns directly with the government will be strictly optional.

"Taxpayers will always have choices for how they file their taxes," Werfel told reporters during a conference call Tuesday. "They can use tax software. They can use a trusted tax professional. They can use a paper tax return. We'd rather they file electronically, sure. But they have that choice."

Many Democrats have long favored a direct filing option. Legislation passed last year gave the IRS $15 million to study the idea.

"Democrats are committed to the proposition that it shouldn't cost hundreds of dollars and many more hours of time simply to follow the law," Senate Finance Committee chairman Ron Wyden, D-Ore., said during a hearing last month. "When it comes to filing taxes online, the status quo is unacceptable."

Through surveys, the IRS found significant interest in a government-run filing system, but also challenges.

One survey found 72% of taxpayers would be "very interested" or "somewhat interested" in a system that allowed them to file returns directly with the government at no cost. The option was most popular with younger people, those with limited English skills and people who do their own taxes.

"If the government is requiring me to file, they should offer a free service," one survey respondent said.

Concerns remain about online filing

Other participants were concerned, however, that the tax collector might not provide them with the largest refund or the smallest tax bill — a potential conflict that's been highlighted by commercial tax preparers.

The IRS estimates that setting up and operating a direct file system would cost the government between $64 million and $249 million annually, depending on the number of users and the complexity of returns it could handle.

One challenge is how to integrate state tax returns, which would make a IRS-run system more attractive. The system could also be a stepping stone to having the IRS fill in parts of a tax return itself, using information from employers and other sources.

The next step in the process is to let some real taxpayers try using the system next year.

"The best way to be successful is to begin with a limited scope pilot that allows the IRS to test functionality for some taxpayers, evaluate success, and use lessons learned to inform the growth of the tool," Deputy Treasury Secretary Wally Adeyemo wrote, in a letter authorizing the test.

The scale of the experiment and the kinds of taxpayers who will be eligible is yet to be determined.