by Dick Hall-Sizemore
The 2022 federal Inflation Reduction Act directed the Internal Revenue Service (IRS) to prepare for Congress a report on “a potential IRS-run free direct e-file tax return system (Direct File).” After delivering the report to Congress, the IRS proceeded to develop a pilot e-file tax return system and made it available to taxpayers in 12 states for the 2024 filing season.
The response of taxpayers to IRS surveys was highly favorable, as were reports in the media (see here and here). After making adjustments to the program based on results from the pilot, the IRS announced that it would make the program, called Direct File, available nationwide in 2025.
Direct File, as used in the pilot, was limited to relatively simple tax returns. For example, all of a taxpayer’s income had to be from wages and no more than $1,500 in interest income. Also, only the standard deduction was available. In its announcement of nationwide application, the IRS stated it was examining ways to expand the number of tax situations the program could cover in 2025 and in the future. Millions of taxpayers across the country will have the option in 2025 of directly completing and filing their income tax returns electronically, at no cost, with the IRS.
Alas, Virginia taxpayers will not be in that number.
For taxpayers to have access to Direct File, the IRS requires their state to agree to participate. Gov. Glenn Youngkin recently sent a letter to the Virginia Congressional delegation stating that Virginia will not be participating this tax season.
The Governor listed several reasons for this decision. Upon closer examination, those reasons seem shaky, at best, and, in some cases, not applicable.
- Virginia law does not authorize participation and for the Commonwealth to participate in Direct File, the General Assembly must change the law.– In explaining this assertion, the Governor referred to 2010 legislation that established the Virginia Free File program for low-income taxpayers, which coordinates with the IRS Free File program. The governor concludes, “This existing law effectively prohibits participation in the new program.”
That conclusion does not follow from a reading of the legislation. That act requires the state to:
… enter into a non-monetary agreement with companies in the electronic tax preparation and filing industry (the Consortium for Virginia) to work together to offer free, online tax return preparation and filing services to 70 percent of Virginia taxpayers with the lowest incomes, the same as the IRS Free File program for federal taxpayers.
Obviously, the purpose of the law was to provide low-income Virginia taxpayers free access to preparation and filing services for their state tax returns. It had nothing to do with the preparation and filing of their federal tax returns; that was covered by a separate federal program. There is nothing in that law that would prohibit the Commonwealth from participating in a federal program that would enable all Virginia taxpayers who met the eligibility criteria (not based on income levels) to get free preparation and filing services for their federal income tax forms.
2. Virginia’s tax processing system, the Integrated Revenue Management System (IRMS) is old and would need replacing to meet the terms of Direct File.— It is true that IRMS is old and needs replacing, but this administration seems to have been sitting on its hands about doing anything about it.
The 2022 Appropriation Act required the Department of Taxation “to conduct a strategic planning exercise to identify and evaluate options for the replacement of IRMS.” The department contracted with Gartner, a national IT consulting company, to conduct the assessment. In a December 2022 report to the General Assembly, the department reported that Gartner had concluded that the more than 20-year-old IRMS was “rapidly becoming obsolete.” Like many legacy systems that had been custom built, it had become somewhat jerry-rigged with “40+ interrelated applications, including multiple databases, with the core systems using custom-coding and built on technology approaching obsolescence.”
Gartner recommended replacing IRMS with “with a single-vendor Commercial-Off-the-Shelf (COTS) integrated tax system.” It estimated replacement would take four years to implement with a cost estimate of $71-107 million.
That finding and recommendation was made in December 2022. It took the Dept. of Taxation more than 18 months before it issued a Request for Proposals (RFP) for a Commercial-Off-the-Shelf integrated tax system. The deadline for submission of proposals is the end of this month. The agency’s estimated timeline is 60 months.
3. The General Assembly would not fund the replacement of IRMS.–In his letter, the Governor complained, “I introduced $150 million in funding for IRMS and other critical state government information technology systems in December of last year, but this necessary funding was not included by the General Assembly in the final budget returned to my desk.” This statement is only partly accurate. He did request $150 million in funding for information technology systems, but IRMS was not specifically mentioned in the budget language. The request was a general, vague request. (See the actual language here, para M.)
Two issues need to be noted. First, the legislature has historically guarded what it views as its prerogative to designate how information technology funding is to be allocated, rather than provide the executive branch a big chunk of money to be spent as it deems best. Whether that is a sound approach is a legitimate question, but a question for another day.
Second, the Dept. of Taxation had not even issued its RFP for a new system in December 2023, so it was not clear how much funding the agency would need to replace IRMS nor when the funding would be needed. The General Assembly had this in mind when it did appropriate $1 million “for anticipated costs related to the replacement of the state’s Integrated Revenue Management System (IRMS)” and required an “update on [the workgroup’s] findings and recommendations to the Governor and the Chairs of the House Appropriations and Senate Finance and Appropriations Committees by November 1, 2024.” Clearly, the legislature is supporting the replacement of IRMS; it just wants to wait until it has more details regarding the cost and schedule before appropriating the funds.
This issue of replacing IRMS begs the question of why participation in Direct File is contingent on its replacement. As reported in The Washington Post, “The IRS requires that to join Direct File, a state have its own online option for filing a state return that can be linked from the IRS’s site after the taxpayer completes the federal return.” As anyone who has used TurboTax knows, Virginia has its own online option for “filing a state return that can be linked from the IRS’s site after the taxpayer completes the federal return.” This ability is also made clear on the Dept. of Taxation website. It shouldn’t be too hard to modify the state’s online option to add Direct File to all the commercial preparation systems that are already linked to it. A cynical person might think that those commercial vendors might be pressuring the Governor not to allow such a linkage
4. Legal issues with IRS authority.– The Governor referred to “substantial legal issues” raised by “state attorneys general that have yet to be resolved.” He is referring to a letter signed by 13 Republican state attorneys general, including Virginia’s Jason Miyares, to the U.S. Dept. of the Treasury asserting that the Direct File program is illegal. “Congress has never granted the Department of the Treasury authority to create a Direct File program,” the letter declares. The statutory mission of the IRS is to collect taxes as set out in federal law. Congress does not get into the mechanics of how that is done. Furthermore, Congress did not prohibit the creation of a Direct File program. If these state attorneys general thought they had even a slim chance of a viable case, they would have filed suit in federal court to enjoin the implementation of Direct File. That they have not filed suit speaks volumes about their claim of illegality. The “substantial legal issues” claimed by Youngkin do not exist.
There are political issues, however. Because they apparently do not think the courts would offer a favorable route, Republicans in Congress are trying to kill Direct File with legislation. (See here and here.)
Virginia taxpayers deserve a better explanation from their governor as to why he is denying them free access to federal tax preparation and filing services next year.
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