Around this time every year, empty retail outlets all across the land are rented out by tax preparation businesses advertising “cheap tax preparation”, “get your tax refund now!” or “instant cash back on your taxes!” The concept itself is all well and good and, ever mindful of a household’s dollar, these types of businesses tend to attract customers but how accurate are these tax preparation businesses and what is the cost of an inaccurate income tax return?
In 2008, the U.S. Treasury Department randomly posed as taxpayers and had their income tax returns prepared by 28 different tax preparation businesses. They found that only 39% of the income tax returns were accurate and a third of all inaccurately prepared tax returns were due to intentional misconduct rather than a liberal interpretation of the law.
The sample size is small and it is unclear how the government determined what constituted an accurate return. However, it does highlight a problem. In many jurisdictions, tax preparation businesses are not regulated and are unlicensed and there is no minimum standard of competence. In contrast, accountants are licensed and bound by standards of professional conduct.
Even larger, more well established, tax preparation businesses have had their own high-profile problems. In 2006, H & R Block had to restate previous years’ earnings due partially due to income tax accounting errors. In other words, the tax preparers could not even prepare its own taxes correctly.
The issue with tax preparation houses is three-fold: (i) you get what you pay for in life and may of these businesses work on a cheap, cheap, cheap model; (ii) it is difficult to track down many smaller tax preparation businesses if there is a problem which is not often detected until well after income taxes have been filed and tax preparation shops have moved on; and (iii) the liability to people who prepare income tax returns, for both tax preparation businesses and accountants, can be relatively modest.
The final point is often something most taxpayers do not understand. The taxpayer, regardless of whether it uses a tax preparation business, book-keeper, accountant, tax lawyer or family member, is ultimately responsible for any inaccurate or incorrect income tax returns. The liability of accountants who incorrectly file your taxes is equal to the interest and penalties that you otherwise would not have paid but for the inaccurate or incorrect return plus the fees for another accountant to rectify the return. The same applies to other non-accounting tax preparers keeping in mind that: (i) you may not be able to find them; or (ii) they may not have errors and omissions insurance to pay out a valid claim.
Simply put, the denied deduction or reassessment, if illegal, will fall back on the taxpayer itself and finger-pointing is generally not a valid defense to the tax authorities. It may make them sympathetic in terms of a payment schedule if the circumstances are extenuating. But, if the tax authority’s position is ultimately proven to be correct, the buck stops at the taxpayer.
Hiring the wrong people is only half of the equation on why a tax return may be incorrect. It is tempting for a taxpayer to instruct a tax preparation business or accountant to claim deductions which are not there or illegal (or to make illegal claims on an on-line tax preparation software). After all, the thinking goes, if I am paying you money, you do what I tell you to do. Avoid this temptation.
Taxpayers who are employees have a relatively narrow band of tax deductions and tax credits. Don’t get creative outside of it since such creativity will stick out like a sore thumb. Income made by businesses have more deductions and a relatively lower threshold of deductibility. However, the rules do tend to be complicated and beyond the scope of either retail based tax-preparation businesses, accountants who prepare mainly personal income tax returns or on-line tax preparation software once the business gets to a certain size (once you have a series of inter-related companies, it is best to hire an accountant since the range of deductions and the danger of denied deductions increases at the same time).
The moral of the story is always the same for all things personal finance related. Do not be tempted by people promising you secret deductions which will give you a great tax refund- there are no magic bullet solutions in life. Delegate and do not abdicate your responsibilities. Be educated about income taxes by visiting some tax resources but keep in mind it is general information and not specific advise. If in doubt, hire good talent. Good luck.
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