Tax Returns – Are They Really All Created Equal?

As we approach Tax Season, I wonder how many people understand the potentially vast differences in the quality of tax return preparation? Are tax returns really the commodity that they seem to be? Is a tax return prepared by the tax service in the mall of the same quality as that prepared by a major CPA firm? What does it mean to have a “quality” tax return? In fact, can a tax return be prepared in such a way as to reduce income taxes?

As someone who has been involved in the tax return preparation process for almost 30 years, let me share some thoughts on this subject.

Accuracy in a tax return simply means that the information provided by the client was reflected on the tax return. It does not mean that the tax return was prepared in the BEST way it could have been prepared. In fact, I RARELY see a tax return from a new client that was prepared the way I would prepare it.

Let me give you some examples. Suppose you have some expenses that could either qualify as investment expenses or business expenses. Either classification would be “deductible” on the tax return. BUT, a business expense is MORE DEDUCTIBLE than an investment expense. How is that possible? An investment expense is deducted on Schedule A and is classified as a “Miscellaneous Itemized Deduction.” There are several limitations on a miscellaneous itemized deduction. First, you only get to deduct these type of expenses to the extent they exceed 2% of your income. So, if you have $300,000 of income and $7,000 of investment expenses, you only get to deduct $1,000. What’s worse is that if you are in the Alternative Minimum Tax like millions of taxpayers, you don’t get any benefit for your investment expenses.

On the other hand, if you were able to deduct these same expense on your Schedule C or your Schedule E, you would be able to deduct 100% of the expenses. In addition, the expenses would reduce your self-employment income from your business. That’s another 15.3% tax benefit on top of the income tax benefit.

Another example of less than stellar tax return preparation relates to depreciation. Depreciation is the government’s gift back to investors, especially real estate investors, for investing in long-term assets such as equipment and buildings. What most tax preparers don’t understand is the idea of a cost segregation or chattel appraisal. The whole goal with depreciation is to get more of it sooner. This provides the investor with a terrific tax benefit in the early years of property ownership. And under the important wealth creation principles of leverage and velocity, the sooner we have cash, the sooner we can invest it and obtain major returns from our investment. The problem appears to be a lack of knowledge from many tax preparers and CPAs about the rules surrounding cost segregation.

The one area where I do see mistakes relates to those taxpayers who file returns in multiple states. This is a specialty area of mine, which I teach at Arizona State University. Even in the major firms, there is a lack of understanding by the Federal tax departments of the many opportunities for tax savings when preparing multistate tax returns.

What it comes down to is whether your tax preparer/CPA has the knowledge and creativity necessary to prepare the BEST return possible. And is it worth it to you to pay a little more to get the better result? Are you focused on the amount you pay your advisors or are you focused on the return they provide you on your investment? Let me give you an example.

Suppose you have a choice of paying $750 for your tax return to a small CPA firm or $2,000 to an innovative, knowledgeable firm. All things being equal, anyone would choose to pay the lesser amount. But what if all things are not equal? What if the $750 gets you an adequate, accurate return but the $2,000 would get you a return where you pay $5,000 less in tax? Which is the better deal? In one, you are out $750 with no return on your investment. In the other, you are net ahead $3,000. Clearly, the $2,000 fee returns a greater value.

This tax season, review your own tax situation and the advice you are receiving from your tax preparer/CPA. Are you getting the return on investment you want? Are you getting the planning ideas you need? Are your taxes going down or do they continue to increase? Taxes are such a major part of your wealth creation that you cannot afford to ignore one of the most important part of the tax planning process – tax return preparation.

Warmest regards,

Tom

Tax Returns

Taxes are compulsory charges or levies collected by states or anything that functions like a state. In a modern society, taxes are usually levied in money. Taxes have always been gathered in one way or the other. Tribal governments used to collect taxes either in the form of labor, produce or even gold.

In the past, taxes have sometimes funded wars or projects. In the modern context, taxes are essential to help a country build infrastructure, offer education, maintain law and order, finance economic structures, roads, administration, defense, etc.

In 1913, President Woodrow Wilson set up the Federal Income Tax. This income tax system deducted about 1% to 7% of a person?s income. Ever since then, new taxes have been added, and after World War I, the American Tax Code has become four times bigger.

In America, citizens who earn above a certain level are expected to file tax returns, and pay taxes if applicable. You are not expected to file returns if you have salaries and pensions taxed under Pay As You Earn (PAYE). This is because the correct amount of tax is being deducted at source.

Tax returns are essentially forms given by the Internal Revenue Service (IRS) in which all the details of income and incurred expenses have to be given. The taxes that you have to pay are calculated based on this. An individual can calculate these taxes, or the IRS could do it.

The form has one page, which everyone has to complete, and nine supplementary forms, which people with specific types of income have to file. There is also a supplementary booklet that helps to file taxes.

You are expected to file returns if you are self-employed, have other income received in gross and from which taxes have not been cut, such as rental income from property, interest in a national savings income account, etc. Returns would also have to be filed if the taxation rate is high or complex.

Sometimes the IRS many issue tax return forms to you even if you pay taxes under PAYE. This happens if you have changed jobs and it is to check if your taxation is in order.

Always file your tax returns if you know that the correct amount of tax has not been paid on your income. Do not wait for the IRS to send you a tax return. If you fail to do so you may pay a fine or incur a penalty. Several people have gone to prison for failing to file their taxes correctly.

Send your tax returns back to the local tax office by January 31st after the end of the tax year; otherwise you will automatically incur penalties. If you want the IRS to do the tax calculations, you must send the completed return to the local tax office by September 30th following the end of the tax year.

Tax Returns in Australia – An Outline

In Australia, tax returns are generally due on October 31 for the year ending June 30 in the same calendar year. The financial year runs from July 1 to June 30. Contrast this with USA whose fiscal year runs from October 1 to September 30. Extensions to the due date are available, especially when the tax return is submitted via a tax agent. Tax returns may be submitted by post or electronically using the ATO’s e-Tax software.

The Australian taxation system is perceived to be quite complex and this view is supported by the fact that close to 80% of Australian’s use a tax agent to assist with the preparation of their tax returns.

Australian businesses may be required to pay taxes to all levels of local, state and federal governments. In Australia these taxes are used to pay for the delivery of public services such as the public hospital system and roads.

Australian tax law defines stringent reporting requirements in relation to tax returns in Australia. The returns you are required to submit are determined by your business structure and operating conditions. This outline considers sole traders, partnerships, trusts and companies. It also touches on the issue of fringe benefits tax.

Income Tax

Income tax is imposed by the Federal Government in Australia and so is consistent across all states. This has not always been the case. Prior to World War II income tax was imposed by the various State Governments. It is the most significant ax providing the greatest contribution to public revenue.

A company must lodge a company tax return. The income tax of the company is different from your personal income tax for which you need to lodge a personal return. The return will show the company’s net income which is the amount of income less allowed deductions. The corporate income tax rate is fixed at 30% of the net taxable income which is at a similar level to the United States, Mexico, New Zealand, Turkey and the United Kingdom (source: OECD Tax Database). Compare this to to Hungary’s 16% and the Slovak Republic’s 19% and at the other end of the scale, Spain with a corporate tax rate of 35%.

A Trust must lodge a trust tax return specifying its income less expenses and deductions. The beneficiaries of the trust, must also report any income or benefit received from the trust. This includes any assessable income such as salary, wages, dividends and rental income.

A partnership must lodge a partnership tax return. The return must show the net income which is calculated by subtracting expenses and other deductions from the gross income. Each partner must report their share of the partnership net income, salary or wage, dividends and rental income in their individual return.

A sole trader operates their business in the name of the owner. Their taxable income or loss is reported in their individual return as well as any other income in the form of salary and wages, dividends and rental income, minus any deductions that are allowed to be claimed against these amounts.

Both partnership and sole trader tax returns are effectively reporting on the income of the individual rather than on a corporate entity. Individual tax rates are calculated on a progressive scale as opposed to the corporate tax rate which is a flat percentage across the whole income range.

Business Activity Statement (BAS)

Businesses with turnover greater than $75,000 p.a. ($150,000 for non-profit organisations) are required to submit a GST return, commonly called a BAS. Business falling below the threshold may still elect to become GST registered and would then need to lodge a GST return. Except for Canada which has a value added tax rate of 7%, Australia’s GST, ay 10%, is the lowest in comparison to other countries. For example, New Zealand’s is 12.5%, the UK’s is 17.5% and Ireland’s is 21%. The GST system was introduced in Australia in July 2000 by the Howard Government and replaced other taxes such as the state based sales tax. The income derived from the GST is distributed to the states to enable the provision of state based public services such as education.

Fringe Benefit Tax (FBT)

Fringe Benefit Tax (FBT) is a tax that is paid on specific benefits employees, or their associates, receive from an employer in lieu of salary or wages. Common examples are: low interest loan, company car and some entertainment benefits.