Why people prepare their own tax returns

Most Americans have the capacity to prepare their own tax returns. But should they? In cases where self preparation is not logical and is not cost-effective, what is the underlying reason driving the decision to self-prepare tax returns? This blog post explores some observations,

Self-prepared tax returns

About half of all individual tax payers can and should submit their own tax returns. For these taxpayers, the value of the benefits of using a paid professional tax preparer may not outweigh the cost. This is typically true when the income comes only from salary and interest, deductions are not itemized and the taxpayer does not qualify for an earned income tax credit. Some in this category may elect to use a paid tax preparer anyway and it appears that the benefits are more psychological that economic. Others use a paid preparer in order to access tax refund anticipation loan. This gives faster access to cash but the concept has dubious value. Tax preparation fees are lowest for this group. as we might expect.

Illogical decisions

I recently received this email message below from a client. I knew immediately that his change of strategy was a strategic mistake in the long-term, regardless of what he says right now. After all, the primary purpose of our work together was to keep him out of trouble with taxing authorities so that he wouldn’t be kept awake at night as he was before we met. Whatever is motivating him today is different from what caused him to come to me in the first place.

Tony:

I have undertaken Turbo Tax myself this year and will not need your services.

Thanks
Sam

my response:

Sam:
Thanks for the head’s up. You may recall that my work has primarily been focused on tax planning and representation work for solving tax problems and not so much tax return preparation. The comic reference in the tax professional’s industry is “we fix TurboTax returns”.

Intuit, the company that makes TurboTax, reports privately that so many of its customers either give up or have questions that the company actually enlists an army of professional folks like me and publishes professional accountant profiles online (mine is at http://proadvisor.intuit.com/quickbooks-help/tony-novak)  for referral to help out on these cases later when its customers have questions. We know that a majority of tax returns do, in fact, have errors and the IRS is simply becoming more efficient at catching those errors.

So I hope this doesn’t apply to you but if it does, I am available.
Tony

Now I know from our personal communications that this is a person who should definitely not be preparing his own tax return. I wonder about the motivation. I suspect that his spouse is not supportive of his decision, but I don’t know for sure and I’m certainly not planning to interject between them. He was caught by auditors in the past taking overly aggressive tax positions (I represented him in the audit) and I suspect that he intends to resume with this improper practice when he prepares his own return this year. I know that he will eventually regret preparing his own tax returns but I’m in a disadvantaged and self-serving position to argue or dissuade. So while I don’t know, of course, what his specific outcome will be, I do know that clients, collectively, will pay more for representation than they did for professional preparation services.

Perhaps the memories of his pain had faded. Apparently his primary focus is no longer on addressing the pain of tax problems or he has become convinced that he can do this himself. Now that the past pain of tax compliance goof-ups is gone there is now some other primary motivation.

My client’s situation is unique. Yet this experience caused me to wonder about the motivation and psychological process that causes other people to to prepare their own tax return in a wider range of situations.

The true cost of self-prepared returns

The true cost of self-prepared tax returns is far more than the cost of the software. The cost is best evaluated as the difference in final cost (preparation plus tax paid) after all audits and adjustments. Of course we don’t know that until years later. But even if we value the taxpayer’s time at $0, the higher amounts of total initial tax paid by self-filers is more than paid with similar professionally prepared returns even after adjusting for the preparer’s fee according to the available data (covered in earlier posts).

Five reasons taxpayers prepare their own tax returns

There may be at least five reasons that taxpayers prepare their own tax return:

1. The tax return is simple and easy and they qualify for “freefile”. This is probably the most sound reason. No doubt that the majority of tax filers in the U.S. with income under $65,000 in a single state, a W-2 and simple financial circumstances can and should be able to file their own tax return without professional help. This should apply to the majority of Americans. Consider leveraging the money you save by investing in more profitable help like tax and financial planning. But beyond that majority group, the government makes taxes complicated in a hurry and the risks of incurring penalties increase sharply. It is well proven, for example, that no two taxpayers or professional tax preparers will come up with the same result for even the most common types of moderately complicated personal income tax returns. Most of the people reading this blog would presumably fall into the more complicated tax return classification. Within this sub-section of taxpayers, it is equally well-established that the amount of taxes paid and the number of tax-related problems makes professional tax preparation an easy decision.
2. Don’t want to pay a professional preparer to save money. Despite the typical evidence that paying for professional preparation is the logical decision, some people resist this approach on emotional reasons or simply because immediate cash flow is insufficient to hire a preparer. Higher income people pay more in the long run by doing their own taxes but they might not care so much about cost. Another accountant suggested “I think some people are just ‘cheap’”. If that generalization is true then I wonder what impact this has on the psychology that goes into other similar financial decisions. Is a person who makes the lowest cost option without consideration of the overall result likely to be successful? I don’t see much evidence of this in successful individuals and I prefer to assume that people act logically based on the economic information available to them. In Sam’s case, for example, I don’t think this is the reason. He knows that I’m priced less than other area tax preparers (I heard that he ‘shopped around’ after I gave him my price last year and that he independently confirmed that the price was low). In addition, I know that Sam earns more per hour than I do so it is logical to presume that he is actually costing himself money by preparing his own tax return.
3. Dissatisfied with preparer’s service. Some people have had a bad experience with a professional preparer.  I am not aware of any statistical data but there is plenty of anecdotal evidence. Every week I hear horror stories in person or online that are nothing other than a shocking embarrassment to the profession. I’m not immune to this; I accidentally insulted a business owner client by being unable to remember her name when we met in the community. She didn’t return this year.
4. Tax return does not meet professional preparation standards. Tax preparers today face significant risks for not doing their work properly. If a taxpayer lacks records, wants to fudge numbers or simply is willing to reduce taxes without support, then it is inappropriate for a professional preparer to sign and submit the tax return. While some tax preparers take inappropriate risks, the vast majority of professional tax preparers follow the law. The IRS is smart enough to recognize this abnormality in fact pattern so when a tax return that normally would be professionally prepared is filed directly by the taxpayer, an auditor smells that something may not be right. If this is the case, a professional preparer is smartest to simply allow the taxpayer to excuse themselves from the engagement and not look back. That doesn’t mean that I won’t be asked to fix the tax return and alleviate tax penalties later.
5. Because they can. Another accountant pointed out to me that some people prepare their own tax return simply because they can; without regard to the comparative cost or risk or efficiency of the process. But just because you can doesn’t mean you should or that a successful outcome means that the original decision was sound. The accountant used an example of a surgeon who spent 4 1/2 hours on his return and incurred as much expense in tax consulting help as it would have cost to prepare the return. Perhaps self-preparers are curious, enjoy the mental exercise or learning experience, want to maintain privacy, have sadomasochistic tendencies or for any other reason just want to do it on their own. That is fine from a humanist perspective; yet perhaps this is not a logical situation that an accountant is trained and equipped to deal with. My work and writing focuses on obtaining the best tangible result and not so much on catering to human interests and whims. I’ve not worked with anyone with this mindset, probably as a result of how I develop client relationships outside of the tax realm.