Is Free Tax Preparation Worth the Price?

If you have requested an automatic extension of time to file your Form 1040 and are thinking about whether to use some of the free tax preparation services on the Internet, here are some observations that might be useful to you.

But first, you should know that I'm semi-retired and limit my tax services to the preparation of some international tax forms that are required for foreign corporations, foreign trusts and various foreign investments. I no longer prepare the type of tax returns discussed below.

Clearly, anything that is free on the Internet is intended to be a magnet to attract people who may be prospects for some other kind of product or service. It's all about advertising. Most of us don't mind being confronted with some advertising in order to save some money, so the free services are likely to have some appeal. But how useful are these services? 

I use a professional tax preparation program from Pro-Series, a division of Intuit, the company that markets the Quickbooks and Turbo-Tax software programs. Pro-Series is an excellent program and has a lot of features that are designed to help the professional user to avoid mistakes. But it would be very confusing for anyone who is not intimately familiar with the U.S. tax system and how it works. I also think it would be difficult to use this system if you don’t' already know how to prepare a tax return by hand. The program is easy for me because it is so well designed that it anticipates how a professional tax preparer works and thinks. A few years ago, I also used the Turbo-Tax program. I found it to be somewhat frustrating because it was designed for the consumer who needs to taken through the tax return step-by-step. For those who know how to prepare a tax return, it's very slow and sometimes frustrating to use. But it's an excellent program for the novice and the cost is negligible. (I think it's about $30.)

Every year Money Magazine used to have a contest between 50 tax preparers -- one from every state. They give them all the same data and the preparers used the data to prepare a tax return as if it were for a real client. The preparers were also required to show how much they would charge for the sample tax return. In most years, the tax preparers all produced returns with different results and different fees. No two were identical. 

Why? Given the same data, a computer program will produce the exact same results every time. All of these tax professionals do use computers to prepare their returns. So why are the results different? 

It's because of the judgment and training that is required to prepare a tax return.  The tax laws are based on concepts of accounting and finance that are often confusing to those who have not studied the subject in depth.

Is every source of cash taxable income? Is every expense a deduction? When does an expense result in a tax credit instead of a deduction? What kind of income is it or what kind of expense is it? What tax form does it go on? When is this particular item subject to tax as income or deductible as an expense? If a home is used for business, which items of expense can be allocated to the home office schedule? Can you deduct the cost of a mobile phone if it is used for business? Is the taxpayer at risk with respect to an investment that has lost value? Is the taxpayer actively involved in the enterprise? When is a business a hobby or vice versa? Can some worthless securities be deducted this year? Are all living costs deductible for someone in a nursing home? Can you deduct medical costs paid for an elderly parent? Etc., etc, etc. 

I often work on fixing tax returns that other tax preparers have messed up because they didn't know the rules for reporting income from offshore banks, mutual funds, foreign business ventures, etc. It isn't that they don't know how to prepare a U.S. tax return. They just aren't familiar with the obscure sections of the law relating to offshore transactions and with the unique forms that relate to offshore activities.  The same problem will face the taxpayer who is trying to prepare a return with a free tax preparation service, but who is not familiar with the subject matter.
 
I haven't tried to count them, but someone has said there are over 1,700 pages in the tax code. The IRS regulations are about three times as extensive. There are thousands of court cases that deal with tax disputes and there are many thousands of private rulings by the IRS to answer questions that taxpayers have about ambiguous issues. There are literally hundreds of different tax forms that may be required. Most of the various states also have an income tax and their tax rules usually are different from the federal rules in some respect. Many taxpayers have income from sources outside their state of residence and they may be required to file tax returns in multiple states. Nearly every kind of income from outside the U.S. is subject to special rules and reporting requirements. About 15 years ago, the Congress began phasing in various changes in the tax law and some provisions were phased out over time. Many of the deductions or credits are changed (indexed) each year to adjust for inflation. Even the tax rates change every year.

For those who have very simple returns without any complicated issues, a free tax preparation program on the Internet may be helpful as a way to double check the accuracy of your return. Otherwise, it could be foolish to use such a program if you might have some complications in your return and you don't know the answers to the kinds of questions illustrated above.