[Tax Season] 35% of Americans Who Owe Can't Afford Their Tax Bill

IRS Direct File is a pilot program where eligible taxpayers can electronically file 2023 federal tax returns directly with the IRS for free. The pilot program is currently available in 12 states to taxpayers who meet certain eligibility criteria (e.g., those who do not itemize their deductions). For the full description and eligibility criteria, see the IRS website.

For eligible taxpayers who have relatively simple federal income tax returns, using Direct File can be a free and easy way to file their federal taxes. In general, taxpayers with more complex returns, such who have business income or who itemize their deductions, often utilize the services of a paid accountant or software.

Every American's tax situation may be different, and each has varying levels of abilities to be able to prepare their own taxes.

The new IRS DirectFile is a pilot program starting in 2024 (for 2023 taxes). It is being rolled out only for certain states (every state was invited to participate, but the IRS was only able to accommodate 12 states in 2024). The program is free, and tax returns are filed directly with the IRS. There is no need to mail in a return or use a company to e-file.

Those earning only wages and salaries (as opposed to investment and business income) would most benefit from the program. Due to our mandated reporting system, the IRS already has total income figures for all wage earners. Businesses must report all wages and salaries paid to employees to the IRS. The IRS also has individual information on interest earned on bank accounts and other investments, as well as social security payments and unemployment payments. All that income is added up to reach the total income amount. Then come the subtractions.

Approximately 90% of Americans take the standard deduction (as opposed to the 10% who itemize their deductions). The tax code also has credits that are subtractions from the tax owed. The Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC) are two of the larger ones available to qualified individuals.

Under the pilot program, those taxpayers qualifying for the EITC and CTC may use the free DirectFile program to apply deductions and credits to reach the amount of tax due. The program takes you step by step. In addition, the IRS will have individuals available to answer questions as you complete the program online. You may use a computer, a tablet, or even a smartphone. The information on taxpayers who can take advantage of the program is available on the IRS website.

Which Americans would benefit from filing through a paid service such as an accountant or paid software instead?

When other types of income are involved, such as when a person has their own business or gains or losses from the sale of capital assets (capital gains and losses), the IRS DirectFile program cannot yet accommodate a free filing program for those items. If a person chooses to itemize their deductions (those are deductions for charitable contributions, medical expenses, mortgage interest, and other expenses), the program is unable to assist taxpayers with those items. I expect if the pilot is successful, the IRS will be able to add more items to the free file program. The DirectFile program is also available only for federal taxes, not state taxes (if an individual's state taxes income).

A credit is available for certain businesses run by individuals, and a tax preparer or a commercial tax software program may be more helpful. Commercial tax preparation software is still free for those with low incomes. Those eight companies are listed on the IRS website. Two companies previously offered free file for low-income taxpayers (H&R Block and TurboTax) but withdrew from the IRS partnership.

Beware of certain companies that advertise free tax preparation and filing. Many times, those companies later inform the user that the return preparation is not, in fact, free. Once a person has input much of their information, they simply consent to pay the cost because they have gone so far into the program and would rather not begin all over with another service.

The main, likely sole, advantage of the IRS Direct File service will be that it is free. While the system is not fully functional nor universally available, I find it highly unlikely that it will be a better system than a paid software service or an accountant. An intriguing feature of the system is direct access to IRS support services. This could be a significant advantage for the system if it works well. It is still too early to see how the rollout proceeds and eventual product functions.

The service does not support taxpayers with business income or itemized deductions, so those would need to use other services. Additionally, the service does not fully integrate with state returns, at least at this time. This would mean those required to file a state return would need to use a different service for that, leaving half of the tax job undone. The simplicity and time savings of using a single service to take care of both the federal and state returns may make the costs associated with a paid service worthwhile.

Currently, the IRS Direct File system is only in the pilot stage. However, based on IRS guidance, the system will cater to people who do not itemize or have self-employed or business income. With that said, the average American resident could benefit from this program. Remember that this system is only for filing your federal tax returns. So, if you live in a state with a state income tax, you must meet your state responsibilities.

It is very important to file taxes on time, and there can be negative consequences to falling behind on your taxes. Some of these consequences can include interest build-up, penalties, seizing of money and assets, and travel restrictions. Again, it is best to file taxes on time and to seek professional advice from a qualified tax professional for any relevant questions.

The failure to pay your tax owed after computing it on your annual federal income tax return will be assessed a Failure to Pay penalty, which is 0.5% of the amount owed and not paid per month, up to 25% total. Moreover, you will also be assessed interest on the amount owed and not paid per month based on the Treasury's quarterly interest rates.

It is important to file a return on time, even if a person is unable to pay the taxes in full. There are penalties for failure to file a return on time. There are, of course, also penalties for failure to pay the tax, but at least a person will not have to pay both a failure to file and a failure to pay penalty.

My biggest piece of advice is not to ignore IRS notices. It is human nature to engage in avoidance behavior sometimes, but the IRS does not go away. Penalties will build, and interest will be due on the amount that should have been paid. There are numerous payment options. See the IRS website for more details.

The IRS will collaborate with you to produce a payment plan or might accept an offer for less tax than due if you cannot pay the tax you owe. Beware of companies that advertise that with their help, you can "pay pennies on the dollar." These are for-profit companies, and they will charge a fee. You may work out arrangements with the IRS without the assistance of a third Party.

If a taxpayer falls behind on their tax payments, the IRS will increase its efforts to collect. One of the more extreme measures the IRS can use is wage garnishment. In rare circumstances where criminal activity is involved, the IRS can seize assets to cover the taxes owed. For most normal people and typical situations, interest can be a big problem. Unpaid taxes will accrue interest, making the amounts owed greater.

Failing to file or pay can create a snowball effect on the amount owed to the government. In other words, your balance owed to the government will grow with time due to the assessment of penalties and interest associated with the balance owed.

One frequently overlooked deduction is the itemized deduction for State and Local Taxes. From 2018-2025, the Tax Cuts and Jobs Act limits this deduction to $10,000. Among the deductible taxes, taxpayers can elect between deducting state and local income taxes or state and local general sales taxes (which include retail sales taxes). Electing the latter can be more appealing for residents of states that levy no state income tax, like Florida and Texas.

If you have a qualified deduction, then you are allowed to use it, generally on Schedule A (Itemized Deductions) for Form 1040. If a taxpayer does not itemize their deductions, then they would use the Standard Deduction based on filing status.

Oddly enough, some people who do not file returns are actually due a refund. If a person is a wage earner, they have already paid tax into the system through withholding. If their withholding is set too high, they are owed a refund from the IRS. This includes some taxpayers who are not required to file returns. A single person who is under the age of sixty-five who makes less than $13,850 is not required to file a federal tax return. However, they may wish to do so in case they have overpaid tax through withholding. If this person is a student, they may be able to claim a credit against tax due by claiming an education tax credit. Information on those credits is available from the IRS.

Due to the complexity of our tax system, it is my experience that many taxpayers believe they are not getting the benefit of unknown tax deductions and credits. Often, this is not the case. On the other hand, there are a multitude of deductions and credits. There are approximately 180 exemptions, deductions, and credits in the U.S. tax code. The vast majority of those apply to very few individuals or businesses.

I frequently advise my students to check for education credits, as those may save them a great deal of tax. This is true even if they were not required to file a tax return at all. The Earned Income Tax Credit is available to certain low-income individuals. In addition, there is both the Child Tax Credit and the Child and Dependent Care Credit. One is for taxpayers who have a child, and the other is an additional credit for individuals who are paying childcare expenses, so they may be gainfully employed. There is a relatively new 20% deduction for "qualified business income" for certain individuals who own their own businesses.

With the tax law changes in 2017, the elimination of many common deductions, and the significant increase in the standard deduction, there are not many overlooked deductions anymore. One of the more curious ones is state sales tax, though. A taxpayer can deduct from their federal income the greater of sales tax paid or state income tax paid.

This usually only applies to taxpayers who live in very low or zero-income tax states, but if the taxpayer has large purchases in the year, like a new car, it can happen that the sales tax is greater than the income tax, and most taxpayers do not think to do the calculation.

The average American resident will not be able to itemize deductions this year because their itemized deductions do not exceed their standard deduction (currently, the standard deduction is between $13,850 for single filers and $27,700 for married filers).

With that said, taxpayers unable to itemize can benefit from deductions that bypass the standard deduction, such as student interest paid and out-of-pocket educator expenses. Furthermore, taxpayers should explore their employer's pre-tax benefit options, such as 401k and 403b retirement plans and medical benefits. Participating in these plans bypasses the standard deduction and immediately reduces one's taxable income for the year.

The Free File program is only available to taxpayers with an adjusted gross income (AGI) of $79,000 or less. The service is self-limiting due to this limitation. You can find more information on the IRS website.