Closing the Gaps in Digital Tax Law

Introduction and Background

In 1998, Congress enacted the Internal Revenue Service Restructuring and Reform Act, which directed the IRS to modernize its administration and expand electronic filing. Title II of the Act set an ambitious benchmark: at least eighty percent of all tax returns should be filed electronically by 2007 [1]. To meet that target, the IRS created the Free File program in 2002. Rather than building its own system, the IRS entered into a Memorandum of Understanding (MOU) with a consortium of private tax-software companies known as the Free File Alliance [2]. Unlike a statute or regulation, however, the MOU imposed no binding legal duties on the companies, relying instead on voluntary compliance. This arrangement reflected a growing reliance on “soft law” and public-private governance—frameworks that coordinate public goals through private actors without creating enforceable legal obligations [3,4]. The agreement also included a pledge by the IRS not to create its own competing system, effectively outsourcing Congress’s directive to the private sector [5].

The contractual design of Free File carried important legal consequences. Human tax preparers are bound by Treasury Circular 230, a set of regulations that impose enforceable duties of competence and honesty, backed by the IRS’s disciplinary authority [6]. The software providers participating in Free File, by contrast, were not subject to any comparable regulatory framework. The IRS lacked authority to sanction or remove noncompliant partners. This distinction created a regulatory accountability gap: while individual tax professionals were regulated, software companies operated outside a comparable regime of oversight.

The consequences of that regulatory gap extend beyond agency design. Weak accountability in digital tax systems affects the very citizens such programs are meant to serve, particularly low-income taxpayers and those with limited digital literacy who rely most on accessible filing tools. The Free File case raises a broader administrative question: whether public duties can be delegated to private entities without undermining the state’s legal obligations of transparency and equity.

Free File’s design typifies the appeal and risk of soft-law governance. Such frameworks lower political and procedural costs for agencies but blur the boundary between public authority and private discretion. In 2019, investigative reporting revealed that several Free File companies had steered taxpayers toward paid products through deceptive design practices, despite their agreement to provide genuinely free services [7]. The IRS responded by reforming the program, banning certain practices and removing the clause that barred it from developing its own filing system, but contractual revisions could not supply retrospective enforcement. Since Free File rested only on a contract, oversight was reactive rather than proactive, and taxpayer participation remained low [8].

With the program weakened, Congress authorized the IRS in the Inflation Reduction Act of 2022 to develop its own government-run option, leading to the creation of Direct File [9]. Piloted in 2024, Direct File offered a statutory foundation absent from Free File. Yet its termination in July 2025 by the Trump administration highlighted a parallel vulnerability: programs lacking durable bipartisan support remain politically fragile even when statutorily authorized [10]. In short, statutory authority without political durability cannot sustain reform.

Taken together, Free File’s accountability gap and Direct File’s political fragility illustrate a failure of design rather than mere implementation. If contracts without statutory force cannot bind private actors, and statutorily authorized programs without bipartisan legitimacy remain politically reversible, then neither form can provide durable public accountability. As tax preparation increasingly relies on AI-driven tools that shape taxpayer decisions, the law must extend enforceable duties to cover digital preparers through amendments to Circular 230 or new statutory frameworks. Only binding and durable legal standards can ensure that innovation in tax filing advances equity rather than perpetuates systemic disparity. The sections that follow examine this structural problem in three stages. First, the legal limits of the Free File MOU; second, the shortcomings of the 2019 reforms; and finally, the fragility of Direct File as a statutory alternative—each illustrating how weak legal design undermines durable accountability in digital tax governance.

The Legal Limits of the Free File MOU

Contractual instruments like the Free File MOU reveal the limits of cooperation as a substitute for regulation. Unlike statutes or formal regulations, an MOU does not create binding legal obligations enforceable against private actors. Because administrative agencies derive their authority from congressional delegation, any duties they impose must rest on statutory authorization. The Free File MOU lacked such a foundation; its terms were contractual rather than regulatory and therefore unenforceable under public law. As a result, the IRS’s agreement with the Free File Alliance functioned as coordination, not regulation—a partnership grounded in mutual benefit rather than legal duty.

Circular 230 provides a useful contrast. It imposes enforceable standards of competence, diligence, and honesty on certified public accountants and tax attorneys, empowering the IRS’s Office of Professional Responsibility to discipline violators through censure, suspension, or disbarment [11]. The asymmetry lies in reach: while individual human preparers are regulated by law, corporate software providers fall entirely outside this framework. The IRS therefore lacked authority to sanction or remove companies that violated the spirit of the MOU.

The regulatory asymmetry became visible when Free File was tested in practice. After investigations revealed that several participating companies had steered taxpayers toward paid services despite their duty to offer free options, the IRS amended the MOU to add new compliance terms. These amendments applied only prospectively—the agency could modify future conditions but could not impose penalties for past misconduct. The Treasury Inspector General for Tax Administration confirmed this limitation, noting that the IRS could “only encourage voluntary compliance” and lacked tools to address prior violations [12]. The result was a system in which violations could be acknowledged but not punished, transforming a congressional directive into a voluntary-compliance scheme where participation replaced accountability.

If Congress intended the expansion of electronic filing as a public duty, delegating that duty through a nonbinding MOU effectively nullified its enforceability. This outcome underscores a broader principle: when administrative responsibilities lack statutory grounding, public accountability becomes contingent on private willingness rather than public law.

Reform Without Remedy

The IRS’s 2019 Free File revisions corrected visible abuses but could not fix the underlying legal defect because they remained contractual rather than regulatory. Following public outcry over hidden free options and misleading navigation links, the agency negotiated revisions to the Free File MOU to prohibit such tactics and to remove the clause that barred it from developing its own competing system [13]. On paper, these changes expanded oversight, but in practice they left the core problem untouched. Because the IRS still lacked statutory authority to impose penalties or revoke participation, compliance remained voluntary.

Policy correction cannot substitute for legal reform under the Administrative Procedure Act (APA). Policy changes depend on continued cooperation between agencies and private actors, while legal reform derives its force from statutory delegation and carries enforceable consequences for noncompliance. Without congressional action, the IRS could not transform Free File into an accountable regulatory system. The 2019 reforms thus illustrate the limits of self-regulation in a domain where public trust depends on enforceable law. Even after the revised MOU took effect, participation continued to decline, and taxpayer usage fell below five percent of those eligible [14]. The program’s persistent weakness demonstrates that regulatory authority cannot be replaced by goodwill or administrative cooperation. Without statutory or regulatory backing, enforcement remains aspirational rather than real.

From Contract to Statute: The Fragility of Direct File

Direct File shows how statutory grounding can restore public control over e-filing, while its 2025 termination reveals the separate problem of political durability. Congress’s authorization of the program in the Inflation Reduction Act of 2022 marked the first statutory attempt to reassert government control over electronic filing [15]. Unlike Free File, Direct File rested on legislative authority and public funding, giving the IRS power to design and enforce its own free system. This statutory base solved the accountability problem that constrained Free File—but only temporarily. When the Trump administration ended the program in July 2025, citing concerns over government competition with private firms, it showed that legal authority alone cannot guarantee institutional stability without bipartisan support [16].

The contrast between Free File and Direct File reveals two dimensions of fragility in digital governance. The former failed for lack of enforceability; the latter for lack of political durability. Together, they expose a deeper administrative dilemma: how to sustain both authority and stability in a regulatory environment increasingly mediated by technology. The solution lies not in multiplying programs but in constructing statutory frameworks that bind both agencies and private actors through enforceable duties.

As the IRS now integrates algorithmic tools into tax preparation, the problem of accountability extends beyond corporate actors to the systems themselves. Algorithms can replicate or conceal biases in tax compliance, making transparency and auditability essential conditions of lawful administration. Without statutory standards for algorithmic decision-making, digital tax systems risk reproducing the same dependence on voluntary compliance that undermined Free File. Ensuring that innovation in tax filing remains consistent with principles of equity and due process will therefore require bridging the gap between technological design and legal enforceability.

Footnotes

[1] Internal Revenue Service Restructuring and Reform Act of 1998. Pub. L. No. 105-206, 112 Stat. 685 (1998).

[2] Internal Revenue Service. About the Free File Alliance. IRS.gov, 2023. https://www.irs.gov/e-file-providers/about-the-free-file-alliance.

[3] Cihon, Peter, Ryan Hagemann, Mark É. Verstraete, and Gary Marchant, eds., AI Soft Law Database: Final Report (Arizona State University, 2022), https://lsi.asulaw.org/softlaw/wp-content/uploads/sites/7/2022/08/final-database-report-002-compressed.pdf.

[4] Abbott, Kenneth W., and Duncan Snidal. “The Influence of ‘Soft Law’ Grows in International Governance.” Chatham House (June 2021), https://www.chathamhouse.org/2021/06/influence-soft-law-grows-international-governance.

[5] U.S. Department of the Treasury and Free File Alliance. Memorandum of Understanding on Service Standards and Disputes. 2002.

[6] U.S. Department of the Treasury. Regulations Governing Practice Before the Internal Revenue Service (Circular 230). Washington, D.C.: 2018.

[7] Elliott, Justin, and Paul Kiel. “Inside TurboTax’s 20-Year Fight to Stop Americans From Filing Their Taxes for Free.” ProPublica, October 17, 2019. https://www.propublica.org/article/inside-turbotax-20-year-fight-to-stop-americans-from-filing-taxes-for-free.

[8] Treasury Inspector General for Tax Administration (TIGTA). Oversight of the Free File Program Needs Improvement. Report No. 2020-40-009. Washington, D.C.: TIGTA, 2020.

[9] Inflation Reduction Act of 2022. Pub. L. No. 117-169, 136 Stat. 1818 (2022).

[10] Rappeport, Alan. “Trump Administration Ends IRS Direct File Pilot.” New York Times, July 12, 2025.

[11] U.S. Department of the Treasury, Regulations Governing Practice Before the Internal Revenue Service (Circular 230) (Washington, D.C., 2018), §§10.20–10.52, https://www.irs.gov/pub/irs-pdf/pcir230.pdf. 

[12] Treasury Inspector General for Tax Administration (TIGTA), Oversight of the Free File Program Needs Improvement, Report No. 2020-40-009 (Washington, D.C.: TIGTA, 2020), 4–6. 

[13] Internal Revenue Service, Free File Program Agreement: Memorandum of Understanding (Washington, D.C.: 2019), https://www.irs.gov/pub/irs-utl/free_file_mou_2019.pdf. 

[14] Treasury Inspector General for Tax Administration (TIGTA), Oversight of the Free File Program Needs Improvement, Report No. 2020-40-009 (Washington, D.C.: TIGTA, 2020), 8–9. 

[15] Inflation Reduction Act of 2022, Pub. L. No. 117-169, 136 Stat. 1818 (2022).

[16] Alan Rappeport, “Trump Administration Ends IRS Direct File Pilot,” New York Times, July 12, 2025.