Understanding IRS Direct File and what it means for tax pros and consumers

What are the benefits of Direct File for taxpayers?

Currently, IRS Direct File offers limited benefits to taxpayers, the main one being cost savings. For those who meet the rather restrictive eligibility requirements, IRS Direct File eliminates the need to pay for third-party tax preparation software or services. 

While IRS Direct File is convenient, allowing individuals to complete their returns at their own pace from the comfort of their home, so do a number of other DIY tax solutions. And while 9 out of 10 refunds are processed within 21 days, there’s no guarantee that using IRS Direct File will ensure getting a refund faster.

Past the immediate benefits, broader implications for taxpayers include increased accessibility and hopefully more taxpayers finding it easier to file their taxes accurately and on time. But there is a potential learning curve: Some taxpayers may need time to adjust to the new system, especially for those who are not technologically savvy. 

What are the limitations of IRS Direct File for taxpayers?

When it comes to who is eligible to use IRS Direct File, unfortunately, the program is currently limited to people with simple tax returns in a handful of states.

The basics

IRS Direct File only supports forms 1040 and 1040-SR, and the individuals filing must be U.S. residents. While IRS Direct File does support dependents, it’s only if the dependent is claimed by the custodial parent. Lastly, IRS Direct File does support language and accessibility preferences (Schedule LPE, Form 9000).

Income eligibility

Unlike VITA and some other programs, IRS Direct File has no maximum income threshold. However, it can only support certain types of income, including wages, interest of $1,500 or less, unemployment compensation, Social Security, and Tier I Railroad Retirement Benefits.

Deductions, adjustments, & credits

Perhaps the most limiting part of the IRS Direct File program as it stands today is the limited number of deductions, adjustments, and credits that it can handle. Currently, IRS Direct File supports the standard deduction, the child tax credit and credit for other dependents, the earned income tax credit, claiming credits for disallowance, the student loan interest deduction, and the educator expenses deduction.

Residency restriction

Lastly, for the pilot program, participants are eligible only if they are full-year residents of one of 12 pilot states – eight states without state income taxes, and our states that agreed to partner with the IRS on the pilot. 

Where IRS Direct File falls short 

As part of IRS Direct File, there is a customer service option that offers – according to the IRS – very limited and general guidance. Customer service does not have access to taxpayer information, and they cannot provide personalized advice. This is where the tax professional’s expertise shines through – providing personalized advice and recommendations based on training, technology, and access to authoritative research.

Validating information.

A common complaint from taxpayers is that they didn’t want to submit a return with an error only to get a rejection. This can range from entering the incorrect PIN number to entering information from a tax form and hoping that it’s correct. With professional tax preparers, the stress of whether the data and information are correct isn’t sitting on the taxpayers’ shoulders, it’s on yours. 

According to the post-filing season report, quite possibly the most common feature request from taxpayers was the ability to prepopulate returns with tax information, especially those tax returns that employers and others have to file with the IRS, such as W-2’s, 1099-INT’s, and basic demographic information. With access to tools that taxpayers don’t, tax pros can leverage various tools to reduce and remove the data-entry portion of the digital tax workflow and offer taxpayers what they are looking for: the ability to review a return and confirm what’s changed or if anything is incorrect.

Not available to most taxpayers

Currently, IRS Direct File is only available to individual taxpayers who are full-time residents of one of twelve states and meet a rather restrictive list of eligibility requirements. By servicing those taxpayers – including entities – who are not eligible to use Direct File.

How tax pros can minimize the impact of IRS Direct File to their bottom line.

Whether you are a taxpayer, tax professional, or part of a tax firm, preparation for IRS Direct Filing is key. 

Seasonal tax professionals and tax offices

The long-term implications for professional tax preparers and tax offices are broad and uncertain. While there is a threat that IRS Direct File and other free file options will erode the lower end of the tax preparation market, how much impact firms will see on their bottom line depends on how far eligibility in these free file programs expands and what professional tax preparers take to offset this potential threat. 

One strategy to consider is offering workshops or informational sessions for clients to educate them about the new system. This requires being familiar with the basics of the IRS Direct Filing platform. 

Another is to focus on the client experience, which includes proactive communication about various tax and legislative updates that may impact clients. This requires investing in training and continuing education to stay ahead of the curve. 

Tax and accounting firms

Even if filing taxes becomes free for many individuals, individuals with more complex financial situations will still feel compelled to process their taxes via a certified tax professional. The same may apply to individuals with ‘simple’ straightforward returns and financial situations who are looking for professional advice to maximize deductions and credits that they will not receive through IRS Direct File. 

Firms should take this opportunity to evaluate their current service offerings to identify areas where there are opportunities to add value beyond basic tax preparation. Consider adjusting your business model to focus more on advisory and specialized tax services. This may include taking steps such as investing in advanced tax software that complements the IRS’s platform, could enhance service offerings, and offer clients and staff a more modern firm experience.

Consider how your firm’s current tech stack supports its needs now and in the future. Your professional tax software should enhance return accuracy through advanced calculations and robust error diagnostics. It should also help eliminate time-consuming and often frustrating tasks through automation to increase overall efficiency.

Looking to the future

IRS Direct File represents a significant shift in the tax landscape, aiming to make tax filing more accessible, accurate, and cost-effective. While it poses challenges for traditional tax preparers and firms, it also offers opportunities to innovate and provide higher-value services. By understanding the changes and preparing accordingly, tax professionals can navigate this transition successfully and continue to meet their tax obligations efficiently, without worry.