Recently I had an online conversation with an older successful business owner who apparently did not know that her business was subject to local income taxes. I don’t know the background or how this happened. I suspect that limited communication skills years ago played a role for this non-English native. Since there is no statute of limitations for the tax authority to collect the tax, this is a serious issue. A quick calculation in my head indicated that the tax liability could be a full year’s gross income – enough to bankrupt the business! Over the past week this conversation haunted me and caused me to re-examine the whole issue of local income taxes.
Who is affected by local income tax?
Other online sources list the jurisdictions that charge a local income tax so there is no need to list them here. In general, older cities tend to charge local income taxes. Overall about 20 million taxpayers pay local taxes. The average local tax rate is just below one percent of income according to ax Foundation and other sources.
Bad local tax advice in Pennsylvania
Intuit’s TurboTax web site published incorrect information about local income tax in Pennsylvania and occasionally I am asked by skeptical clients why my advice is different. Obviously I can’t control what TurboTax publishes but their statement that all Pennsylvania taxpayers are subject to local income tax is simply not true. See this blog post about Philadelphia taxpayer, as one example where a local tax return filing is not required. This is not the first or only time that the company was wrong on a tax issue. A TV advertisement for TurboTax that played during this past Superbowl contained false or misleading information. I’m not faulting Intuit for occasionally making a mistake but rather saying hat you can’t believe everything you see on TV or read online.
Statute of limitations
If you file a local tax return but pay the wrong amount of tax then there is usually a limit on the length of time the tax collector can pursue collection.
If you do not file a local tax return – even if the reason is that you didn’t know about it – the statute of limitations does not start. The tax collector can then pursue collection without limit. As an aside, local tax collectors have the general reputation of being more aggressive than state revenue officials or the IRS. That lack of statutory protection may be a fundamentally unfair provision of our tax law but not something that we must live with.
Professional positions vary
I polled a few other professionals’ opinions on local tax return preparation service for this blog post. A New Jersey CPA made a strong argument that because CPAs usually embrace the totality of an issue in their engagement, this leads to a ‘standard of care’ where the local tax preparation is presumed. Another CPA accurately points out that the engagement letter is the definitive determinant of whether local tax return preparation is included in the tax preparer’s service . Then a tax lawyer in Pennsylvania warned me that “standing like grim death on the engagement letter” is a bad idea.
One tax preparation firm I worked with always prepared to local tax returns on paper for less than $30 unless a client specifically declined that service. Their goal was to produce “the highest quality tax return” and was paper-focused so that made sense. Another larger CPA firm handled it on a case by case basis but had a staff member print out he local tax requirements for each client as a reminder that accompanied the tax file.
My own tax practice was built online through the e-file system in a paperless environment. I focus on efficiency and delivering value. I’ve always advised clients to file the local tax return themselves. I remind them that local taxes can be filed online at the tax authority’s web site in about three minutes and that this is easier and less expensive than having me handle it for them. I seems like I can offer better value by giving simple clear instructions. Of course my tax engagement letter contains the standard provision stating that we are agreeing to specific work and excluding all other services not specified. I am also reminded that there is a whole world of potential taxes that I don’t handle.
I have a few clients that, for their individual reasons, have me handle their local income tax filing. One is unusually complex and his work adds at least several hours work requirement and several hundred dollars to their tax preparation fee. Another client just doesn’t do any of his own paperwork in any subject matter. But these are the exceptions. Most are pleased with the arrangement where they file their own local income tax.