Wednesday, December 5, 2012

Should You Do Your Own Taxes?

With tax season coming up, you might be wondering how your taxes will get done. In this post I hope to provide a little insight into whether preparing taxes by yourself is good idea or not.

I believe there are 3 ways to get your taxes done 1) by yourself, 2) "big box" tax preparers 3) your local CPA or other Tax professional.

1) By yourself -
If you don't have a particularly complex return I believe there are a few times you can skate by with preparing taxes yourself:
a) you are not in school (or if you are in school you are familiar with the education credits such as the lifetime learning credit, or the american opportunity credit and know when to appropriately take each)
b) you do not have kids
c) you only recieved income listed on a W-2
d) you plan on taking the standard deduction (i.e. you do not have substantial deductible expenses like a mortgage, charitable contributions, medical expenses etc).

If you fit into this category and feel somewhat comfortable with preparing your own taxes, than feel free to use whatever your DIY software you prefer. Of course your ability to prepare your own taxes depends on your competency level.

2) "big box" tax preparers -
Due to sheer volume of returns prepared, it is likely that I will offend someone by saying this, but I think this is the worst option. Last year I was offered a job at one of these "Big Box" firms (and denied) and I learned that thier hiring process is very poor. Most of the preparers go through a tax theory crash course and begin preparing taxes. It could be possible that your tax preparer is just working parttime to supplement his walmart paycheck.

After studying only a few years of tax accounting, it is nearly impossible for these people to be "professionals" after a few months crash course. I personally feel that one should never use this alternative (unless maybe you could do it yourself, but aren't up to the task)

3) Local Tax CPA
I believe that finding a trusted tax advisor is the best option for preparing your taxes. Dave Ramsey (a personal finance guru) recently put out an article highlighting that people who paid for a preparer typically save between $347-$841 on thier taxes. When you are likely to pay $100-$250 for an average return, you win here. (depending on your actual circumstances fees or savings can differ).

Keep in mind that not all CPA's are created equal, and that you should find a CPA firm that is most fitting for you. CPA firms are typically equipped to serve a certain type of client. For example a Big 4 firm usually is equipped to serve the largest of clients, like Microsoft, Amazon, Boeing and their executives. Some CPA's specialize in smaller businesses/individuals. Regardless of your choice of CPA keep in mind you are paying for quality advice and direction. When choosing a tax advisor find someone who:

a) "has the heart of a teacher". Regardless of how much you would (or wouldn't) like to know about your taxes, if your advisor has the heart of a teacher you know they aren't just in it for the money, but are willing to help and teach you.

b) plans to build a relationship with you. A good preparer knows that 2013 isn't the only time you need your taxes done. A good CPA wants to plan to help minimize your tax liability for the future, instead of leaving the tax return up to fate to decide.

c) is familiar with the portion of the tax code that pertains to your needs.

Lastly, I would like to highlight a personal experience to show the importance of using a quality accountant.

Last year I had a friend who wanted to me solve a complicated problem on his taxes in which he prepared online. After solving his problem I noticed he was neglecting to take a specific credit he did not know about. After filing the return he saved over $1,000 just by having me look over it.

There are two points to be made. First, you can't let webMD properly diagnose you with cancer and you can't let free online tax software properly diagnose your tax problems. Second, its not about what you know, its about what you don't know; as well as what you think you know, but actually don't.

Tax benefits of Children Part 2: Exemptions

Another benefit when you have children is the extra tax exemption.

Exemptions are basically deductions based on the size of your household. For each person there is a $3,800 exemption (in 2012). Every exemption can save you $380-$1330 in tax dollars depending on your income and what tax bracket you are in.

As a college student I have heard of parents trying to hang on to that exemption as long as possible, but the reality is if your student child is qualified to file on their own, there are situations when you might want to reconsider. Here is just one scenario:

Scenario: Letting the student child file their own return
(assuming a tax rate of 10%).

If a child is free to file their own taxes, they not only will get their personal exemption  ($380 value), but they will be allowed to take an additional standard deduction ($595 value).

If a parent is in a 35% tax bracket, they are not eligible to take the education credit. (The education credit's income limit for married filing jointly is $180,000).

If the student needs to acquire loans, or at least pay a partial amount for their schooling without scholarship, the value of an education credit could be up to $2,500. (education credits are not discussed in detail here).

Total potential savings = $2,145 = ($380 + 545 + $2500) - ($1330)
Total potential savings = (added value to student) - (parent forgoing the student's personal exemption)

I know not everybody's parents make $180,000+ but the analysis gets more complicated if I hadn't made that assumption.

Everybody's situation is different and each situation should be evaluated independently by your trusted tax adviser.