You turn to qualified medical, legal and (of course!) financial planning professionals. Make sure you seek the services of a tax professional as well. Attempting to prepare your tax return by yourself is a bad idea. The Internal Revenue Code consists of more than 67,000 pages. There are nearly 600 tax forms. Even the instruction booklet for Form 1040 is 155 pages!
This extreme complexity means it is highly unlikely that the typical consumer will correctly prepare his or her own return. It not only takes hours to complete the forms -- once you determine which forms need completing -- but mistakes are costly. You could even find yourself the subject of an audit.
It is precisely because of this fear that many prepare-it-yourself taxpayers deliberately refrain from claiming the deductions, exemptions and credits they are entitled to. The result: They pay far more in taxes than they actually owe. And they spend hours doing it, all the while fretting if they're completing the right forms in the right way.
Tax preparation software is of questionable help. These programs ask you a variety of questions, but many users find the questions confusing. If you skip a question or answer incorrectly, the software will produce the wrong forms or complete them incorrectly.
And you're out the 50 bucks or so it cost to buy the program.
In an ideal world, paying taxes would be automatic, with virtually no paperwork or effort involved. (OK, in an ideal world, you wouldn't have to pay taxes at all. But let's be realistic, people.)
After all, it's bad enough that you have to pay taxes. The last thing you want to do is spend more money in order to pay the taxes you owe.
That explains why so many people prepare their own returns. But as we've shown, preparing your own return is a bad idea. A much better idea is to have someone else prepare your return for you.
But this doesn't mean you should turn to your nephew or neighbor. Nix also the idea of turning to one of those no-appointment-needed walk-in services, for they are too often staffed with under-trained, part-time seasonal employees. There are two reasons not to have your son-in-law or daughter prepare your tax return -- even if he or she is an MBA. Unless that friend or relative is devoting 20 or more hours a week to the tax and accounting field, his knowledge is probably no better than yours. Worse, if the IRS ever comes calling, that preparer cannot represent you.
This is why you must insist that the person who prepares your return is a certified public accountant, enrolled agent or tax attorney. With narrow exceptions, these are the only people who can represent you in matters pertaining to the IRS. (Everyone is familiar with CPAs and attorneys; EAs are tax professionals who have completed coursework and passed an examination certifying their competency to prepare tax returns.)
Not only will these folks help you in dealing with the IRS, they'll stand behind their work. Say your friend makes a mistake on your return. Two years later, the IRS sends you a notice demanding that you pay additional tax, plus penalties and interest. But the mistake wasn't your fault -- you relied on your friend. So will you ask him or her to pay the penalty and interest?
But if your CPA, EA or attorney makes a mistake that causes you to owe additional tax, you'll pay only the tax. He'll pay any interest or penalties owed. (It's unreasonable to ask preparers to pay the tax itself; that's always the taxpayer's responsibility.)
Why are these folks willing to stand behind their work? Because they're professionals. And as such, they are not only highly ethical, they know that, as professionals, it's highly unlikely that they will make such a mistake. So it's easy to offer a promise when it's so unlikely they'll have to honor it. The situation is rather ironic when you think about it. CPAs, EAs and tax attorneys will defend you before the IRS, and they'll pay for any mistakes. But none of that will likely ever be needed because they are very likely to prepare your return correctly in the first place. If you doubt this, consider the statistics: According to the Treasury Department, 56 percent of all the returns prepared in 2007 by volunteer tax preparers contained mistakes. And just as many of those returns caused taxpayers to pay too much in taxes as too little. Take, for example, a client who owned mutual funds, sold his investments and replaced them with new securities. He failed to understand that investment companies, when issuing Form 1099, report the gross proceeds of the liquidation to the IRS rather than the taxable gain. He also failed to note that his cost basis should have been adjusted upward to reflect many years of reinvested dividends and capital gains. Because of his lack of understanding of Schedule D and the proper tax reporting of investment sales, he was about to send the IRS a check for $8,000, which included hundreds of dollars in interest and penalties. When he told us about it, we immediately sent him to a CPA who was able to show the IRS that its calculations were wrong. Result: The client owed no additional tax, and therefore no penalties or interest, either. But the CPA did bill the client $750. It was certainly worth it.
Taxpayers who insist on being pennywise should consider the professional's fee from a different perspective. According to the statistics released by the IRS, the typical married couple in 2005 with an adjusted gross income between $75,000 and $100,000 per year paid $7,300 in federal income taxes. That's an effective tax rate of approximately 8.4 percent.
If the CPA, EA or tax attorney's fee is $600, that's just 0.7 percent of their income. In other words, retaining the services of a tax professional means the family's total tax bill, including the cost of tax preparation, is 9.1 percent rather than 8.4 percent.
And considering all the time and aggravation that the professional will save you, plus interest and penalties resulting from errors you might make, this small increase in your effective tax rate is well worth it. By the way, the fee you pay your tax preparer is tax-deductible. (Even Congress acknowledges you need a CPA!)