One aspect that makes Equiom unique is that we do not sit around waiting for clients to call with ideas to explore. As a practice, we dedicate a portion of our teams time and resources to exploring and researching concepts that we find intriguing. At any given time we may have 2-3 research projects where we identify customer problems or market opportunities that we cannot resist digging into. The costs of testing and exploring new ideas is incredibly low and by designing, testing and sometimes building and even operating our own digital products, it helps us better empathize with our clients and partners and the work required to design, build and operate digital products. When we do work on a project we find interesting, we often will publish it here. This is one such project.
A couple of years ago with partnered with some friends to explore the tax space. We felt it was an interesting bit of research and we wanted to share our findings. Thank you to our friends Kelly Smith and Frank Pinero for partnering with us to explore this area.
Our team has a deep experience in the tax space. We also have a lot of experience with payments and payment systems. There are thousands of banks that all offer payments as a core offering in a variety of forms and many various specialty payments providers that have emerged over the years. If you want to make a payment to someone or something, the options are endless. But if we need to calculate, file and pay taxes, the options are basically the same as they were 20 years ago. The market is dominated by a handful of companies, most of which were dominating the space 10-20 years ago.
Tax, like payments, is also something nearly all adults need. It is one of the most consequential aspects of our financial life, regardless of whether you owe money or expect are fund. The percent of money per year per household dedicated to taxes is typically in the top 3 of expenses or income. Further, financial institutions,not tax filers, have the highest quality and most relevant data to help a user quickly calculate and file taxes. Information such as transaction data, investments, financial holdings and personal data is abundant for financial service providers. Calculating and filing taxes based on this broad set of data is obvious. Further, most financial service providers are held to a much higher standard of security and fraud monitoring than the average tax preparer or digital tax platform. Tax fraud has been a pervasive problem for years, filing taxes with a provider that actually has “bank level security”would go a long way to reducing this problem.
So why then do the vast majority, if not basically all US banks, credit unions and fintechs have essentially zero tax related solutions for their customers, choosing to cede the space to the same few digital platforms and accountants?
Working with a couple of old colleagues and friends, we set out to figure this out.
We spoke to several current and past banking executives, from institutions ranging in size from roughly $1B and up. We found banks and credit unions had long thought of extending into tax,but building and deploying a solution was deemed too expensive and complicated. We found there is nothing preventing banks from entering this space, they just never have. At best, the concept showed up as a strategic priority, but as one executive told us “If I could get one strategic priority accomplished in a given year, that was a major accomplishment.”
At best, the concept showed up as a strategic priority, but as one executive told us “If I could get one strategic priority accomplished in a given year, that was a major accomplishment.”
One area that was crucially apparent in our research was the lack of a solution for banks or credit unions to provide tax. For most products and services, most banks depend on third party platforms for anything from payments to core banking itself and everything n between. For tax, there simply is no third party service provider. The closest is TurboTax by Intuit, partnering with banks as a referral partner for a tiny slice of the revenue generated and little if any reciprocal data sharing. TurboTax holds nearly all the chips in this game and the banks do little if anything to try and tilt the table their direction. Without a platform to deliver the service, banks are probably never going to build it themselves.
What makes tax more complicated than most traditional banking services is the calculation itself and the maintenance of what is basically a massive calculator. To make a tax product work for banks, there are four core challenges that have to be met.
1. Building and maintaining a calculator. This calculator allows users to determine what their tax obligations are for a specific scenario and jurisdictions. For the top players in the space, this means having a staff of upwards of several hundred full time accountants to manage.
2. An integration with the IRS efile system. Not the most complicated integration out there, but it also requires building and maintaining a relationship with the IRS, testing and ensuring a stable connection and if you reach a large enough scale, partnering to prevent and fight fraud and streamline the filing and refund process for tax filers.
3. Processing refunds and tax payments. The collection and disbursement of funds can come in many forms and requires a highly accurate accounting. This is the type of thing banks and financial institutions are excellent at, but with tax, there are some unique challenges and requirements.
4. A method for integrating into a bank or credit unions core banking system.
As we looked at the space, the fourth seemed most daunting to us, having worked with and sold to large banks in the past. The FinTech world has recently moved heavily towards APIs. Stripe, Plaid and Marqeta are three examples of companies that have had massive success building APIs for financial service products such as payments, data aggregation and credit and it cards. They have shown that ease of integration and customization as well as access to a powerful array of tools to increase the speed of innovation and the ability to deploy new services can lead quickly to commercial scale in financial services. More and more banks themselves have created APIs to give developers access to their tools and services, such as Silicon Valley Bank and BBVA, with more in development. This seemed to be the key element that would make tax for banking work.
In some of our other research on a project we nicknamed INFX, we had been playing with a tool that could leverage the syntax used in spreadsheets to create a low code style platform. Using INFX, we believed we could power a tax engine and create the framework to allow banks to quickly and easily integrate and customize a tax solution for their clients. This is what we imagined that might look like:
We started playing around with this approach and found that we could write a simple tax calculator in Excel, use INFX to translate the calculations and then along with a tool such as Swagger.io to publish and manage an API. With a couple of team members working over several weeks, we were able to build a tax API for a tax calculator to prove our hypothesis. Leveraging INFX, one member of our team could codify a tax form and the needed calculations and we could turn that into code that could be customized inside of a third party application. This is what that might look like:
This is what the API documentation looked like:
For now, that is as far as our research has gone. In deeper discussion, we found that at the time, many banks were still intrigued by tax but as is often that case, finding a partner to be a willing first mover is tough. In the 3 years since we dug into this space, the idea continues to crop up and we see others tinkering with it. 2 years ago the founders of Plaid put out a call for just such a product, but so far no one has stepped up.
Further, we spoke with multiple VC about the space and worked with some of them to dig into the topic and explore whether this concept might lead to a venture scale business. Ultimately, we found that the tax space is a tough industry for VC backed companies. Tax has a crazy cycle and finding product market fit can take years, purely based off of the annual cycle of the product. Tax is a SaaS business, but with only one data revolution per year. Also, the industry is highly competitive and customer acquisition costs can be very high, all of which has led to a minimum number of innovative VC backed startups in this space.
We believe that one day, this type of solution will be made available, and the big winner will be individuals and small business owners. Tax is a crucial aspect of everyone’s financial life and the more options available for service and support in this space, beyond the traditional accountants and digital DIY platforms will ultimately be in the best interests of the consumer. We would not be surprised to see one of the emerging leaders in the financial services API space ultimately take on this challenge, as more and more financial service products become accessible via APIs.
We still really like this space, so if you want to get creative with us. Give us a call.