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 As we speak Worldwide. This week: slicing out the intermediary.

On Could 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 lately for steering eligible taxpayers to paid companies.

So is that this new program different? 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 start out off, might you inform us some background on what Free File is?

Jonathan Curry: Yeah, I might be pleased to. The Free File program is an over-two-decades-long, public/non-public 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 regulation set a objective for the IRS to have 80 p.c of taxpayers file electronically by 2007. And the IRS determined that the easiest way to do this was to enlist the assistance of the non-public 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 growing their very own system, sustaining it, overseeing it. They will simply sort of hand that off to another person. In observe, I believe most would say it has been disappointing at finest. Some folks have stronger phrases to say than that.

The usage of 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 had been deliberately steering taxpayers away from free companies and in 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 observe, solely about 2 to three p.c of the taxpayers who’re in any other case eligible for Free File, as in that they meet these earnings 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’re going to let taxpayers file their returns immediately with the IRS as a substitute of going round via 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 mentioned that the IRS was going to do that, it is only a matter of timing and funding.

Quick-forward just a few 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 review the query of what it could take for the IRS to do that.

David D. Stewart: What did the IRS need to 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 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, however it led somebody to truly see it, should you had been to click on via the menus and put together your taxes that approach.

It additionally explored the professionals and cons from an administrative perspective, what it could require from the IRS, the completely different stakeholders that may be concerned, like state tax directors and issues like that. It did not actually come to any type of neat and tidy conclusion, although. It simply type of simply defined the completely different facets of what can be concerned right here.

David D. Stewart: Now I perceive you lately 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 appearing IRS commissioner. He’s a former Treasury assistant secretary for tax coverage. At present, he is at RSM and he is additionally a member of our board of administrators right here at Tax Analysts. And like I mentioned, he is a former IRS commissioner. He is somebody that may know what this may take from an inside perspective, and I believe that is a reasonably worthwhile perspective to have right here.

David D. Stewart: What kind of points did you get into?

Jonathan Curry: Properly, we began together with his impressions of the report, and I do not wish to spoil an excessive amount of, you will need to pay attention for that, however I am going to simply say upfront, he is just a little bit disenchanted with what he noticed there. There’s plenty of unanswered questions in his thoughts, particularly as somebody who’d be desirous about what it could take for this to truly unfold.

He has plenty of issues over the practicality of the IRS moving 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.

Particularly, one of many points we’re actually going to speak about loads is the problem of state tax return submitting, which you could be questioning, who cares about that? We’re speaking concerning the IRS. Properly, taxpayers. I do not find out about you, however after I file my taxes, I file my state and federal on the identical time. And for the IRS to be doing that for you, immediately makes this into an even bigger program than the IRS would possibly wish to get into.

David D. Stewart: Properly, 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 via 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 would possibly appear to be or are there just a few unanswered questions there for you?

David Kautter: The quick reply is not 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 truth, I might in all probability 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 be capable of use direct file and when? In different phrases, what varieties of earnings may very well be reported, will there be limits on the quantity of earnings that may very well be reported? What varieties of exercise may very well be allowable? In different phrases, on the best varieties of exercise query, there are tens of hundreds of 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 varieties of earnings?

Second is, what is going to the person interface appear to be? Will or not it’s simple to know and use?

And third, and this can be a level which I believe is discreet constantly within the report, is what about state tax returns? There are 43 states that impose some type of particular person earnings tax, 41 impose taxes on wages, one imposes a tax solely on curiosity and dividend earnings, one solely imposes a tax on capital beneficial properties. 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.] research that got here out simply earlier than this report was launched that was analyzing taxpayer attitudes in direction of a hypothetical IRS direct-file system, they usually provided a pair completely different situations. However one of many key takeaways was that state tax submitting, the power to file your state taxes concurrently with the federal, was principally the large defining issue between whether or not folks had been extra more likely to wish to swap to an IRS-run system versus sticking with no matter they’ve used beforehand.

David Kautter: I believe that is precisely proper. The power to solely enter knowledge as soon as is important 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 industrial 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 could have any sense of how tough it could be for the IRS to make that operate potential, to make it a simultaneous submitting [of] state and federal?

David Kautter: What’s fascinating concerning the report back to me is it talks about working with state directors and that is all the time necessary, however I can not think about 43 states are going to develop a direct-file program for taxpayers. And so there’s going to need to be an effort right here to resolve this downside a method 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 mentioned that they stay up for listening to from the IRS, however at this level, that collaboration has not but began, which is probably a bit surpris[ing] on condition that the report describes an effort to launch a pilot program in 2024. So maybe state submitting may not be on faucet for no less than the preliminary pilot.

David Kautter: Precisely. There are solely two methods to get this completed that I can see, proper? The states construct direct-file packages or the IRS builds 43 packages. Each state’s tax legal guidelines are considerably completely different; some are dramatically completely different from different states. And so constructing a federal direct-file program is one factor. Constructing 43 state direct-file packages is [a] fully completely different magnitude, and the report acknowledges the significance of having the ability to file on a consolidated foundation, however it simply does not cope with it immediately. And I believe that is likely one of 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, one of the best arguments for the supporters of this, one of the best arguments from critics of this. What’s one of the best factor that would come from this and what is the worst approach this might explode and collapse?

David Kautter: Positive. Properly, let me give attention to this from a coverage viewpoint and administrative viewpoint. I believe one of the best case is the IRS builds an efficient, targeted prototype that is simple to make use of, safe, and fashionable. 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 nicely, and isn’t extensively used, after which discarded. So these are the 2 extremes to me.

Jonathan Curry: Positive. OK. Truthful sufficient. What do you assume it could take for one thing like this to succeed?

David Kautter: Positive. I believe there are three core parts, Jonathan. First, a user-friendly interface that is simple to know and use. Second, there needs to be high-quality, responsive customer support. Questions — regardless of how easy, regardless of how easy the software program is — there’re going to be questions. And if these questions cannot be answered, taxpayers are going to rapidly abandon the system. And third, state tax return functionality, reentering knowledge and paying to file the state return once you’ve simply filed a federal return without cost, I believe is a major difficulty.

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 value cash. Would the IRS must get extra funding for this? What do you type of see?

David Kautter: Positive. The funds are necessary. I believe the one most necessary operational impediment is mindset. At present, the IRS doesn’t present the extent of proactive help that this type of a system would wish. So in different phrases, proper now the IRS does a reasonably 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 type 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 truly persuade folks 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 non-public trade on a regular basis. People who find themselves their complete profession, reactive, are requested to be proactive, construct one thing that individuals really need, versus one thing persons are pressured to do.

And it’s a fully completely different mindset and it provides a completely new dimension. It’s important to be extra proactive, you need to be extra customer-oriented. And I do not wish to say it is the exact opposite, as a result of the IRS engages in outreach and is anxious about taxpayers understanding the tax regulation. So it is not a whole shift, however it’s a major shift.

And certain, the cash’s necessary, and certain, the software program needs to be written in a user-friendly vogue, and also you want buyer help, however 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 had been speaking about with the prototype that they examined, they examined a purposeful prototype of what this may appear to be, and it was morphed so that individuals might see what this seems like. They examined, I believe, with solely about 14 folks, in response to the report, however nonetheless, they examined it they usually mentioned the suggestions to that was truly surprisingly good.

Folks responded saying, they’re like, “Oh, this truly is best than I anticipated the IRS would provide you with.” So it appeared prefer it may need been extra maybe user-friendly that you simply would possibly in any other case envision a state authorities, federal company, developing with one thing.

David Kautter: It is laborious to interpret precisely what which means. I had a good friend who used to say, “Simply because you find yourself on third base doesn’t suggest you hit a triple. You may need been born there.” And I believe in a case like this, you are concerned that the bar is so low, that individuals anticipated it to be such a depressing expertise, that when it wasn’t, they mentioned, “Properly, that is fairly good.”

Once more, it is laborious to inform from the wording within the report, however I questioned whether or not the bar was so modestly low that it was simple for the individuals who had been a part of the 14 who acquired to make use of this piloted software program thought it was higher than they anticipated.

Jonathan Curry: Now, you had been speaking about how one of many benefits the non-public sector has is they should exit and get folks to need their product, whereas the IRS would possibly simply be merely like, “Here 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 folks to modify their return submitting supplier of selection from say, TurboTax, to the IRS?

David Kautter: I believe free can be sufficient for some taxpayers, however it’s laborious to inform what number of. The state return difficulty, I am going to deliver up once more. It is an enormous difficulty. Though it is free, to then flip round, need to reenter the info and pay to file the state tax return, I believe will disappoint many individuals who would possibly in any other case use the IRS direct-file.

Jonathan Curry: After which how does the difficulty of the IRS growing and operating 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 type of see that?

David Kautter: Proper now I believe it is within the formative stage. It isn’t 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 method is sensible. 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 nicely and folks really feel that the info they’re given is goal and that the person response has been favorable, that can go a great distance towards turning round a few of the resistance.

But when folks really feel they’re being spun they usually do not feel they’ve gotten a simple story with respect to the person expertise, I believe it’s going to get dramatically worse.

Jonathan Curry: Alongside these strains, Commissioner [Daniel] Werfel has been within the scorching seat truly recently after it was revealed within the report that the IRS was already growing 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 type of authorizing, “Go forth and do that,” relatively than plunging forward.

You are a former IRS commissioner, so that you’re nicely 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 may need been a misstep, might have been dealt with in another way?

David Kautter: Properly, I believe it’s totally unlucky that the administration moved ahead in the best way that it has. I believe direct submitting with the IRS is a matter that deserves full and open consideration if it is going to have any probability of bipartisan help.

As a substitute, the method adopted thus far, 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 research was perfunctory, that the surveys and the studies had 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 shouldn’t have firsthand information of how this course of—

Jonathan Curry: You are not at present within the commissioner’s seat.

David Kautter: I’m not.

Jonathan Curry: OK, understood. Properly, let’s speak about prices. The research was $15 million for this. The report says the estimated value of growing and operating this, the annual value 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 in response to the report.

Additionally in Washington, everybody likes to speak about value 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 lifelike?

David Kautter: I believe the best understatement in your entire report is its assertion about “appreciable uncertainty” across the improvement value. At one level in my profession, I used to be accountable for the tax know-how funds of a Large 4 accounting agency. Expertise tells me that it’s just about not possible to anticipate all the issues concerned in a challenge of this magnitude.

I believe the prices are considerably understated for no 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 folks with the best expertise or outsource the event or a mix 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 understand how IRS proposes to resolve that downside, 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, in all probability appreciable uncertainty, however they speak about servicing about between 5 million and 25 million taxpayers.

The Free File program, the Free File Alliance, the place the non-public 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: Properly, I believe non-public trade goes to be simply superb on this space, particularly within the quick time period. And the explanations I say which can be, 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 grow to be aware of it, you grow to be snug with the questions. Third, I might say ease of already having final 12 months’s knowledge in a system makes life easier. You’ll be able to evaluate final 12 months to this 12 months.

Considerations concerning 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 will use this metaphor, I am beating it to dying right here. You wore the commissioner’s hat for a time, you have been within the workplace there. Do you assume the IRS needs to be doing this? Now to some extent, maybe it does not matter what they wish to do, they do what they’re advised to do by Congress, Treasury, and so forth. However throughout the constructing, is there a type of eagerness to go on this course?

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 a protracted listing of know-how priorities. In 2019, they issued a modernization report which listed dozens and dozens of packages that they wanted to enhance or develop as a way to serve taxpayers successfully.

It’s laborious to consider that abruptly, direct file has catapulted from not on that listing in any respect, to No. 1 on the listing. So I believe that the IRS has completed a extremely 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 after I was within the appearing commissioner job that was excessive on our listing.

The industrial software program distributors have good merchandise, they work nicely. Knowledge acquired into the system successfully, the IRS had an efficient working partnership with these software program distributors. And so IRS was inclined, no less than after I was there, to give attention to areas [which] wanted help, the place you might considerably enhance the taxpayer expertise, and this was not one in every of them.

It appears to me partly, that is being pushed by a need to assist taxpayers get monetary savings by having the ability to file. And there’s something irrational a few tax system the place the federal authorities needs you to file electronically and will not will let you file immediately with them electronically, the place you need 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’ listing on the IRS on the subject of 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 folks serving to them out with that, they each got here to the conclusion that if that is to succeed, it is going to require management, IRS management, to essentially decide to this. I believe you talked about this earlier, a half-hearted try and identical to, “Here is a direct-file factor. You should use it if you need.” It isn’t going to get off the bottom nicely.

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 got 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 p.c of these taxpayers use that system. Why a dramatic variety of taxpayers, in extra of the three p.c, would abruptly resolve to make use of a direct-file system that the IRS has provide you with as a substitute of the industrial software program that is accessible without cost, shouldn’t be clear to me.

So I believe the one approach this turns into widespread is the system is simple 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 remedy the state tax return downside, I believe, or this can all the time be only a shadow of what it might presumably be.

Jonathan Curry: All proper. Properly, 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 subject and it is going to be fascinating see to see the way it evolves.