January 2008
Should you do your own taxes this year?
Or have them done for you? How to make the right choice.
Fewer than half of all U.S. taxpayers fill out tax forms themselves, using a pencil and the instruction booklet, a software
program, or a Web-based service. More and more, people would rather pay someone else to do the job.
Paid preparers range from your brother-in-law to local storefront operations and national chains such as H&R Block, Jackson Hewitt and Liberty Tax Service. Professional tax preparers include certified public accountants and enrolled agents (sometimes called EAs), who are federally authorized tax specialists. Tax attorneys usually don't prepare individual tax returns, except for the very rich. Last April, a bill was introduced in the Senate that would require licensing of tax preparers by the Treasury Department. At that time, only two states, California and Oregon, licensed tax preparers, "which is a little frightening," says Cindy Hockenberry, spokeswoman for the National Association of Tax Professionals. "Even a barber has to be licensed."
Each type of preparer has advantages and disadvantages, which we detail below. The most important thing to remember, says tax attorney Dennis B. Drapkin, past chairman of the American Bar Association's tax section, is that you are legally responsible for paying the taxes you owe no matter who prepares your return. If you follow poor advice and end up with unpaid taxes, you bear the consequences, which range from interest and penalties to imprisonment if you're convicted of knowingly cheating the government.
HELP IF YOU DO TAXES YOURSELF
If you earn most of your income from wages and you take the standard deductions (raised for 2007 returns to $10,700 for a married couple filing jointly or $5,350 for singles), or if you have few itemized deductions, completing the 1040EZ, 1040A short form, or even the 1040 long form should not be too difficult. And there's no shortage of places to turn for help:
Books. They include "Taxes 2008 for Dummies" and J.K. Lasser's "Your Income Tax 2008: Preparing for your 2007 Tax Return," which can be bought for less than $15 each, and often provide more guidance than the Internal Revenue Service's own instruction booklets.
The Internet and phone help. The IRS Web site, www.irs.gov, provides some help and is a convenient source for publications, forms and links to state-government tax sites. Forms and information taxpayers need to file their returns are consolidated under the 1040 Central link on the home page. The AMT Assistant helps taxpayers determine their AMT liability on their own. Search for AMT Assistant at www.irs.gov. The IRS taxpayer assistance hotline at 800-TAX-1040 (800-829-1040) also offers help. A recent IRS report found hotline help to be accurate 91 percent of the time. (If the guidance an IRS rep gives is later determined incorrect in an audit, you're required by law to pay the correct tax. The agency will not charge you a penalty.)
The IRS also operates Taxpayer Assistance Centers that can help you solve individual and small-business tax problems. You can check your local phone directory for one in your area, or check online at www.irs.gov/localcontacts/index.html.
States also have tax help lines, as does AARP, some public libraries, and social-service agencies. The elderly can turn to a number of free services: AARP, Volunteer Income Tax Assistance (VITA), and Tax Counseling for the Elderly (TCE), which are available in most communities. To find them, call the IRS branch near you.
Software programs. Best sellers include TurboTax Deluxe ($44.95 for federal and state), and H&R Block TaxCut Premium Federal Plus State for $39.95.
Web-based tax-preparation services. They are proliferating, blurring the distinction between doing it yourself and hiring a pro. H&R Block's TaxCut Online Premium + E-file version, for example, costs $19.95. For $79.95, a professional will review, sign, edit, and e-file your submitted return for you. Or you can have your taxes prepared by H&R Block's online office (prices start at $99.95, so visit www.taxcut.com/taxes/online/index.html for an estimate). Prices include preparation of federal form 1040 only. Extra schedules and state and local tax forms add to your bill.
There are more and more Web-based services. Some use TurboTax software, others use their own proprietary software. Most Web operations allow you to file your return electronically with the IRS. Doing so may cut the time it takes you to get your refund to less than two weeks. Keep in mind, though, that Web-based tax-prep services might increase in cost closer to tax time, so don't wait till the last minute to use one. In addition, you can only prepare and file one federal and one state return per account.
Before using any Web service, check its privacy and security policies to see how well the company plans to protect your information. Ideally, your information should not be shared with anyone without your specific permission.
DO-IT-YOURSELF DRAWBACKS
You will have to invest more time and brainpower than ever before. Consumers devoted an average of 26 hours to deciphering, preparing and assembling their 1040 form and common schedules in 2004, according to the National Taxpayers Union, which tracks complexity and other tax issues. In comparison, the same process devoured only 18 hours 17 years ago. The 1040EZ, considered the simplest form in the IRS's inventory, requires nearly four hours now, up from an hour and a half 19 years ago.
A bigger drawback to doing your own taxes is that you might make errors and/or overlook legitimate deductions. For instance, starting this filing season, receipts and dated bank records are needed for all charity contributions, regardless of value. Depending on the tax references or software that you use, you also could miss out on valuable tax-planning advice, how to reduce your future tax bills by increasing before-tax contributions to your 401(k) or 529 College Savings Plans, for example. "Do-it-yourself software can't give you wisdom and judgment," says John Henry Low, a financial planner in Pine Plains, N.Y.
If you figure your taxes without benefit of tax software or online calculators, you also risk making mathematical errors, so check your arithmetic carefully. Even if you use a computer, inputting errors occur, so check each field carefully to make sure your figures correspond to withholding and expense records. (Don't overlook this step even if you have your return professionally prepared.) Occasionally, glitches also show up even in reputable tax programs.
SHOPPING SMART
Using a paid preparer is no guarantee that you will pay the least amount due. According to a Government Accounting Office study, as many as 2 million taxpayers overpaid their 1998 taxes by $945 million because they failed to itemize deductions--and half of the two million used paid preparers. The report cited one taxpayer who overpaid his taxes for several years by $3,500 to $5,000 despite receiving notices from the Internal Revenue Service that he was eligible for the earned income tax credit. He showed the notices to his paid preparer, but the preparer took no action.
Regardless of whom you hire, we recommend you follow these precautions:
WHICH TYPE OF PREPARER IS RIGHT FOR YOU?
Here are the various types of tax preparers and their qualifications, from least to most expensive:
YOUR MOONLIGHTING FRIEND OR RELATIVE
Cost. Inexpensive.
Pros and cons. Convenient, but no quality control. He or she could be well trained, highly credentialed, and up-to-date on tax law, but most likely isn't.
What if you're audited? Unless your pal happens to be a moonlighting certified public accountant, enrolled agent, or attorney, he or she can't legally represent you at most IRS hearings.
Tip. Caveat taxpayer.
STOREFRONT TAX PREPARERS AND NATIONAL CHAINS
Cost. Varies regionally, but usually less than full-time tax pros. Generally, there's a fee for each form, and you could pay $200 or more for itemized state and federal returns with additional schedules. H&R Block says the average its storefront clients paid in the 2007 tax season was $165.
Pros and cons. Convenient but not always inexpensive. The chains offer in-house tax training, but the minimum credential required for part-time seasonal staff is usually a high-school diploma. Pros with more expertise might work side-by-side with new recruits. And as chains try to become one-stop financial shops, you're likely to be pitched everything from high-cost refund anticipation loans to second mortgages (H&R Block alone managed 402,278 traditional brokerage accounts and serviced 427,590 mortgages as of October 2006. Consumers Union, the publisher of Consumer Reports, has advised consumers to steer clear of high-cost refund-anticipation loans.)
What if you're audited? Depending on the sales agreement, the office might or might not assist you. Most preparers cannot legally represent you at IRS hearings. For an additional fee, some preparers offer an insurance policy that covers interest and penalties incurred because of errors they committed.
Tips. Get the most qualified person available. Ask about year-round tax help. Refuse refund-anticipation loans, which come with astronomical interest rates. If you need money fast, use the IRS's e-file program instead. If you're pitched other investment, insurance, or loan products (such as IRAs or second mortgages), compare them with similar products at banks and brokerages. Preparers should be licensed to sell insurance or securities if they offer them. A prospectus must accompany an investment offer.
ENROLLED AGENTS
Cost. Usually more than a chain-store tax preparer, less than or comparable to a certified public accountant.
Pros and cons. Enrolled agents are the only federally licensed tax specialists. They must pass a national qualifying exam and take 24 hours of continuing professional education each year in order to renew their license every three years. Many are former IRS agents or employees. They can handle complicated individual returns as well as those of small businesses and corporations. Some are also have financial-planner credentials. But there are only 46,000 enrolled agents, or about 1 for every 7 CPAs.
What if you're audited? An enrolled agent is legally qualified to represent you in all IRS audits and actions, and your communication is protected with limited confidentiality.
Tips. You can find an enrolled agent by going to www.NAEA.org or the National Association of Tax Professionals, which includes enrolled agent members, at www.natptax.com or by calling NAEA at 800-424-4339.
CERTIFIED PUBLIC ACCOUNTANTS
Cost. $100 to $300 per hour or more.
Pros and cons. CPAs have been trained in business and accounting, passed a state-licensing exam, and met other statutory requirements. They're qualified to prepare financial statements as well as income taxes. But not all CPAs specialize in taxes. Some are credentialed financial planners, and more and more CPAs also sell investments and insurance.
What if you're audited? A CPA can legally represent you in IRS actions and audits. Communication with your CPA is confidential under a 1998 court ruling.
Tips. Seek a CPA with tax expertise and familiarity with your occupation. If the CPA wants to sell you investments, annuities, or life-insurance products for tax-planning purposes, evaluate them against similar products sold elsewhere. To find a CPA in your area, go to the Web site of the American Institute of Certified Public Accountants, at www.aicpa.org/states/info/index.htm, or the National Association of Tax Professionals, at www.natptax.com, or check the phone directory. Ask the CPA for references to check before you settle on the professional you want.
TAX ATTORNEYS
Cost. $200 to $400 per hour or more.
Pros and cons. Tax attorneys have passed a state bar exam and trained in the field of tax law. Most don't prepare individual income-tax returns, but they can plan your estate, draw up wills and trusts, and structure business deals to reduce tax liabilities. They also represent clients in disputes with the IRS and other agencies, and defend them in court.
What if you're audited? Tax attorneys can represent you in any IRS audit, hearing, or trial. Communication between you and your attorney is confidential.
Tips. You probably won't need a tax attorney except for estate planning or business advice. Find an attorney through your state bar association, but ask for references before making a final choice.
E-FILING
This year, the IRS's Free File program, which enables taxpayers to complete and transmit their returns over the Internet, is limited to households with adjusted gross incomes (AGI) of $54,000 or less. Once at the Free File Web site, eligible taxpayers are directed to the Web sites of tax-software companies such as CCH, H&R Block, and Intuit. You must go through the IRS Free File portal to access the free deals.
Even without Free File, the number of taxpayers filing electronically is rising. In 2007, almost 80 million returns were filed electronically using options such as tax software and online tax solutions. The IRS expects millions more to use e-filing this year.
One of the biggest benefits to taxpayers who e-file is the speed with which the IRS grants a refund. Indeed, it takes only about half the time to receive a refund from an e-file as it does to get one from a paper return. Even if you file a paper return, you can trim the waiting time for refunds by a few weeks if you request that the money be directly deposited into your bank account. See line 74 of your Form 1040.
Electronic filing by telephone is no longer available.
Paid preparers range from your brother-in-law to local storefront operations and national chains such as H&R Block, Jackson Hewitt and Liberty Tax Service. Professional tax preparers include certified public accountants and enrolled agents (sometimes called EAs), who are federally authorized tax specialists. Tax attorneys usually don't prepare individual tax returns, except for the very rich. Last April, a bill was introduced in the Senate that would require licensing of tax preparers by the Treasury Department. At that time, only two states, California and Oregon, licensed tax preparers, "which is a little frightening," says Cindy Hockenberry, spokeswoman for the National Association of Tax Professionals. "Even a barber has to be licensed."
Each type of preparer has advantages and disadvantages, which we detail below. The most important thing to remember, says tax attorney Dennis B. Drapkin, past chairman of the American Bar Association's tax section, is that you are legally responsible for paying the taxes you owe no matter who prepares your return. If you follow poor advice and end up with unpaid taxes, you bear the consequences, which range from interest and penalties to imprisonment if you're convicted of knowingly cheating the government.
HELP IF YOU DO TAXES YOURSELF
If you earn most of your income from wages and you take the standard deductions (raised for 2007 returns to $10,700 for a married couple filing jointly or $5,350 for singles), or if you have few itemized deductions, completing the 1040EZ, 1040A short form, or even the 1040 long form should not be too difficult. And there's no shortage of places to turn for help:
Books. They include "Taxes 2008 for Dummies" and J.K. Lasser's "Your Income Tax 2008: Preparing for your 2007 Tax Return," which can be bought for less than $15 each, and often provide more guidance than the Internal Revenue Service's own instruction booklets.
The Internet and phone help. The IRS Web site, www.irs.gov, provides some help and is a convenient source for publications, forms and links to state-government tax sites. Forms and information taxpayers need to file their returns are consolidated under the 1040 Central link on the home page. The AMT Assistant helps taxpayers determine their AMT liability on their own. Search for AMT Assistant at www.irs.gov. The IRS taxpayer assistance hotline at 800-TAX-1040 (800-829-1040) also offers help. A recent IRS report found hotline help to be accurate 91 percent of the time. (If the guidance an IRS rep gives is later determined incorrect in an audit, you're required by law to pay the correct tax. The agency will not charge you a penalty.)
The IRS also operates Taxpayer Assistance Centers that can help you solve individual and small-business tax problems. You can check your local phone directory for one in your area, or check online at www.irs.gov/localcontacts/index.html.
States also have tax help lines, as does AARP, some public libraries, and social-service agencies. The elderly can turn to a number of free services: AARP, Volunteer Income Tax Assistance (VITA), and Tax Counseling for the Elderly (TCE), which are available in most communities. To find them, call the IRS branch near you.
Software programs. Best sellers include TurboTax Deluxe ($44.95 for federal and state), and H&R Block TaxCut Premium Federal Plus State for $39.95.
Web-based tax-preparation services. They are proliferating, blurring the distinction between doing it yourself and hiring a pro. H&R Block's TaxCut Online Premium + E-file version, for example, costs $19.95. For $79.95, a professional will review, sign, edit, and e-file your submitted return for you. Or you can have your taxes prepared by H&R Block's online office (prices start at $99.95, so visit www.taxcut.com/taxes/online/index.html for an estimate). Prices include preparation of federal form 1040 only. Extra schedules and state and local tax forms add to your bill.
There are more and more Web-based services. Some use TurboTax software, others use their own proprietary software. Most Web operations allow you to file your return electronically with the IRS. Doing so may cut the time it takes you to get your refund to less than two weeks. Keep in mind, though, that Web-based tax-prep services might increase in cost closer to tax time, so don't wait till the last minute to use one. In addition, you can only prepare and file one federal and one state return per account.
Before using any Web service, check its privacy and security policies to see how well the company plans to protect your information. Ideally, your information should not be shared with anyone without your specific permission.
DO-IT-YOURSELF DRAWBACKS
You will have to invest more time and brainpower than ever before. Consumers devoted an average of 26 hours to deciphering, preparing and assembling their 1040 form and common schedules in 2004, according to the National Taxpayers Union, which tracks complexity and other tax issues. In comparison, the same process devoured only 18 hours 17 years ago. The 1040EZ, considered the simplest form in the IRS's inventory, requires nearly four hours now, up from an hour and a half 19 years ago.
A bigger drawback to doing your own taxes is that you might make errors and/or overlook legitimate deductions. For instance, starting this filing season, receipts and dated bank records are needed for all charity contributions, regardless of value. Depending on the tax references or software that you use, you also could miss out on valuable tax-planning advice, how to reduce your future tax bills by increasing before-tax contributions to your 401(k) or 529 College Savings Plans, for example. "Do-it-yourself software can't give you wisdom and judgment," says John Henry Low, a financial planner in Pine Plains, N.Y.
If you figure your taxes without benefit of tax software or online calculators, you also risk making mathematical errors, so check your arithmetic carefully. Even if you use a computer, inputting errors occur, so check each field carefully to make sure your figures correspond to withholding and expense records. (Don't overlook this step even if you have your return professionally prepared.) Occasionally, glitches also show up even in reputable tax programs.
SHOPPING SMART
Using a paid preparer is no guarantee that you will pay the least amount due. According to a Government Accounting Office study, as many as 2 million taxpayers overpaid their 1998 taxes by $945 million because they failed to itemize deductions--and half of the two million used paid preparers. The report cited one taxpayer who overpaid his taxes for several years by $3,500 to $5,000 despite receiving notices from the Internal Revenue Service that he was eligible for the earned income tax credit. He showed the notices to his paid preparer, but the preparer took no action.
Regardless of whom you hire, we recommend you follow these precautions:
- Never choose a tax preparer based on a promise of a large refund. (With proper tax planning, your tax liability should match
withholding and other taxes paid during the year. Getting a big refund means you gave an interest-free loan to the government.)
- Reach an agreement on a fee up front. The fee should never be based on the size of the refund.
- Ask for referrals from friends and business associates.
- Find out if the preparer's risk tolerance matches your own, ask how many returns he or she does that are similar to yours,
and how many clients have been audited.
- Never sign a blank tax return or form.
- Ask the preparer what precautions he or she takes to protect your personal data. Ask whether the firm conducts criminal background
checks on employees and how they dispose of old returns (they should be shredded, burned, or pulverized) and protect computer
files.
- Check the return carefully for errors (including names and Social Security numbers) before signing it. Retain a copy for your
records.
Here are the various types of tax preparers and their qualifications, from least to most expensive:
YOUR MOONLIGHTING FRIEND OR RELATIVE
Cost. Inexpensive.
Pros and cons. Convenient, but no quality control. He or she could be well trained, highly credentialed, and up-to-date on tax law, but most likely isn't.
What if you're audited? Unless your pal happens to be a moonlighting certified public accountant, enrolled agent, or attorney, he or she can't legally represent you at most IRS hearings.
Tip. Caveat taxpayer.
STOREFRONT TAX PREPARERS AND NATIONAL CHAINS
Cost. Varies regionally, but usually less than full-time tax pros. Generally, there's a fee for each form, and you could pay $200 or more for itemized state and federal returns with additional schedules. H&R Block says the average its storefront clients paid in the 2007 tax season was $165.
Pros and cons. Convenient but not always inexpensive. The chains offer in-house tax training, but the minimum credential required for part-time seasonal staff is usually a high-school diploma. Pros with more expertise might work side-by-side with new recruits. And as chains try to become one-stop financial shops, you're likely to be pitched everything from high-cost refund anticipation loans to second mortgages (H&R Block alone managed 402,278 traditional brokerage accounts and serviced 427,590 mortgages as of October 2006. Consumers Union, the publisher of Consumer Reports, has advised consumers to steer clear of high-cost refund-anticipation loans.)
What if you're audited? Depending on the sales agreement, the office might or might not assist you. Most preparers cannot legally represent you at IRS hearings. For an additional fee, some preparers offer an insurance policy that covers interest and penalties incurred because of errors they committed.
Tips. Get the most qualified person available. Ask about year-round tax help. Refuse refund-anticipation loans, which come with astronomical interest rates. If you need money fast, use the IRS's e-file program instead. If you're pitched other investment, insurance, or loan products (such as IRAs or second mortgages), compare them with similar products at banks and brokerages. Preparers should be licensed to sell insurance or securities if they offer them. A prospectus must accompany an investment offer.
ENROLLED AGENTS
Cost. Usually more than a chain-store tax preparer, less than or comparable to a certified public accountant.
Pros and cons. Enrolled agents are the only federally licensed tax specialists. They must pass a national qualifying exam and take 24 hours of continuing professional education each year in order to renew their license every three years. Many are former IRS agents or employees. They can handle complicated individual returns as well as those of small businesses and corporations. Some are also have financial-planner credentials. But there are only 46,000 enrolled agents, or about 1 for every 7 CPAs.
What if you're audited? An enrolled agent is legally qualified to represent you in all IRS audits and actions, and your communication is protected with limited confidentiality.
Tips. You can find an enrolled agent by going to www.NAEA.org or the National Association of Tax Professionals, which includes enrolled agent members, at www.natptax.com or by calling NAEA at 800-424-4339.
CERTIFIED PUBLIC ACCOUNTANTS
Cost. $100 to $300 per hour or more.
Pros and cons. CPAs have been trained in business and accounting, passed a state-licensing exam, and met other statutory requirements. They're qualified to prepare financial statements as well as income taxes. But not all CPAs specialize in taxes. Some are credentialed financial planners, and more and more CPAs also sell investments and insurance.
What if you're audited? A CPA can legally represent you in IRS actions and audits. Communication with your CPA is confidential under a 1998 court ruling.
Tips. Seek a CPA with tax expertise and familiarity with your occupation. If the CPA wants to sell you investments, annuities, or life-insurance products for tax-planning purposes, evaluate them against similar products sold elsewhere. To find a CPA in your area, go to the Web site of the American Institute of Certified Public Accountants, at www.aicpa.org/states/info/index.htm, or the National Association of Tax Professionals, at www.natptax.com, or check the phone directory. Ask the CPA for references to check before you settle on the professional you want.
TAX ATTORNEYS
Cost. $200 to $400 per hour or more.
Pros and cons. Tax attorneys have passed a state bar exam and trained in the field of tax law. Most don't prepare individual income-tax returns, but they can plan your estate, draw up wills and trusts, and structure business deals to reduce tax liabilities. They also represent clients in disputes with the IRS and other agencies, and defend them in court.
What if you're audited? Tax attorneys can represent you in any IRS audit, hearing, or trial. Communication between you and your attorney is confidential.
Tips. You probably won't need a tax attorney except for estate planning or business advice. Find an attorney through your state bar association, but ask for references before making a final choice.
E-FILING
This year, the IRS's Free File program, which enables taxpayers to complete and transmit their returns over the Internet, is limited to households with adjusted gross incomes (AGI) of $54,000 or less. Once at the Free File Web site, eligible taxpayers are directed to the Web sites of tax-software companies such as CCH, H&R Block, and Intuit. You must go through the IRS Free File portal to access the free deals.
Even without Free File, the number of taxpayers filing electronically is rising. In 2007, almost 80 million returns were filed electronically using options such as tax software and online tax solutions. The IRS expects millions more to use e-filing this year.
One of the biggest benefits to taxpayers who e-file is the speed with which the IRS grants a refund. Indeed, it takes only about half the time to receive a refund from an e-file as it does to get one from a paper return. Even if you file a paper return, you can trim the waiting time for refunds by a few weeks if you request that the money be directly deposited into your bank account. See line 74 of your Form 1040.
Electronic filing by telephone is no longer available.
