The Internal Revenue Service just announced that it is developing government-run tax preparation software, with the likely goal of creating pre-populated tax returns.
Advocates claim that most people’s taxes are very simple and that the IRS already collects — or can gain access to — the information needed to prepare their returns. They also claim that pre-populating tax returns with this information would save taxpayers time and money and simplify the tax filing process. But would it?
Unsurprisingly, no. The IRS either lacks access or would be unable to collect the bulk of the personal information that taxpayers utilize to claim all the credits and deductions that are owed each year. Consequently, taxpayers would either forfeit some or all of their tax refunds or be forced to challenge the IRS by rejecting their draft returns.
Until now, this has largely been an academic argument between two opposing camps about how a program like this would work (or not work).
As it turns out, we have some very telling evidence of what an IRS-prepared tax return would look like. That’s because the IRS has already been preparing tax returns for several thousand taxpayers each year through a little-known program called “Substitute for Return” (SFR), which permits the IRS to prepare a tax return after determining that a taxpayer is liable for filing a return but has failed to do so.
To prepare an SFR, the IRS uses the same third-party financial data, such as W-2s and 1099s, that proponents of a direct-file system say could be easily used to prepare tax returns for millions of Americans.
Instead of more debate about whether this would work, I conducted an experiment. I’m an IRS Enrolled Agent, which means I have a recognized expertise in tax preparation. Another tax expert prepared SFRs for several hypothetical, yet representative, taxpayers. I then prepared returns for each of these same taxpayers using commercial tax preparation software, to determine what that actual tax liability would be after calculating all of their eligible credits and deductions. We were each double-blind to each other’s work.
For a single mother of two young children with a total annual income of $24,000 and three different jobs, the SFR return calculated a tax of $1,198. In contrast, my professionally prepared return determined she was eligible for an Earned Income Tax Credit (EITC) and Child Tax Credit, with a negative tax liability and substantial refund due of $7,731.
For an elderly couple living on Social Security, modest part-time work and income from a small rental property, the SFR assessed a tax of $763; a fully completed return determined that no tax was due.
For a gig worker with $35,000 in gross income, the SFR calculated a tax of $6,683. In contrast, the professional return made deductions for the taxpayer’s car and other allowable expenses and lowered the tax bill by $1,552.
And finally, for a married couple who are homeowners with two children, substantial medical bills, and deductions for their home mortgage and property taxes, the SFR determined a tax due of $2,832. The more complete professional return calculated a total tax liability of $186 — a savings of $2,646.
In each case, the difference in tax liability between the SFR and my Enrolled Agent prepared return was quite substantial. This experiment helps disprove the notion that most Americans have simple tax returns. In fact, more than 70 million tax-paying households claim either some deductions or some credits, or both.
Moreover, the IRS does not have and can never gain access to the very consequential details of our lives, including who lives in our households or the allowable expenses we incur as property and business owners.
This exercise also proves, once again, the importance of tax refunds, which for many taxpayers is the single largest check they receive all year.
If policymakers want to simplify the tax filing process, the real solution is to simplify the tax code. Until that happens, there is no simple solution — least of all an IRS-prepared tax return — for taxpayers wanting to legitimately minimize their tax bill and maximize their annual refund.
As these experimental returns demonstrate, if something sounds too good to be true, it probably is.
Ryan Ellis is the president of the Center for a Free Economy, and an IRS enrolled agent.