How the Tax Preparation Business Has Changed

At the current time of writing, it has become more difficult to be a tax professional. Our biggest competitor is the D-I-Y tax software industry. People can do their income taxes online and e-file with ease.

This has done a couple of things. For starters, a higher portion of our work consists of handling complex and difficult problems. People filing 1040-EZ’s simply do it themselves. Those who own businesses, rental properties, etc. are more likely to seek the assistance of a tax professional.

I can recall the early days of electronic filing where there was a lot of low hanging fruit for tax professionals. They could simply offer Refund Anticipation Loans and make a lot of easy money. The alternative for most of these filers was to fill out everything by hand and mail in the return. Boy, how things have changed.

Now, each household each has multiple computing devices. There is no longer a need to download and install software. There are many tax preparation apps hosted in the cloud. And, for individual taxpayers with reasonably simple returns, this is a viable solution. On the other hand, filers with complicated returns get frustrated with this software and are better off hiring a tax consultant.

Because of this, good tax preparers should have plenty of job security for the foreseeable future. This is because, as more things get added to the tax code, the complexity requires more knowledge and experience than what was required in the past. Indeed, a portion of the market will consist of people who refuse to use a tax professional even when it makes sense to do so. But, this is something that occurs within the target market of every service industry. For example, in the auto repair industry, there are the stubborn folks will attempt to repair their own car. And they’ll never see the logic of why it makes no sense spend the time and energy to do something just one time. Now, with that rant out of the way, I will briefly cover how income taxes have become more complex and why it’s beneficial for tax accountants.

To put how income taxes have changed into perspective, we need to start from the beginning. Way back, in 1913, Congress passed the income tax law. Couples making over $4,000 were required to pay a tiny 1% tax.

History suggests that more things keep getting added to the tax code rather than getting removed. There was one notable exception, the Taxpayer Reform Act of 1986. But those exceptions are very rare.

The Bush Tax Cuts, implemented in 2001, included some big changes and attracted a lot of attention to income taxes. Some of the provisions have expired while others still exist or have since evolved. Most notably, the top income tax had been reduced to 35% from 39.6%. The American Taxpayer Relief Act of 2012 extended this an additional year, but has since reverted to the 39.6% rate.

Adding items to the tax code includes deductions and credits as well. Some of the new deductions that have emerged over the years include Earned Income Credit, Child Tax Credit, Education Credits, Energy Credits, and more.

The most recent changes added new lines to the 1040 in 2013. This is in addition to having their own new tax forms. First, the Additional Medicare Tax, a 0.9% surcharge, was implemented for taxpayers exceeding a certain income threshold. Second, the Net Investment Income Tax (NIIT) charged up to an additional 3.8% tax for high income earners. Both of these items put together added a lot of confusion for high income taxpayers.

Oftentimes, certain problems arise with no clear-cut way to approach them. The details of a particular problem may not correspond to legacy tax code policy. After the last financial crisis and recession, many investors lost money through Ponzi schemes. There was a lot of debate as to whether to claim Ponzi scheme losses as investment losses or theft. This was important because determining whether the loss was considered an ordinary loss or a capital loss often had a big impact on a taxpayer’s tax liability.

As a result, new legislation was passed in 2013 to address Ponzi schemes. Investors now have a specific set of requirements to go by to determine if a theft loss deduction can be claimed. This goes to show that sometimes it can take years for Congress to act on addressing new issues that arise. Many losses from Ponzi schemes happened in the 2008-09 recession. Examples like this are what eventually lead to the tax code becoming more complex.

Income tax professionals have to spend considerable time keeping up with the changes in the tax code. But, in the end, it’s to our benefit. First, we want to provide value for clients. We should strive to add much more value than the dollar amount we charge them.

Personally, I would prefer a simplified tax system. This is despite the fact that a complicated tax code helps my business. Many Eastern European countries have had success implementing a flat tax. Although I believe the concept of a flat tax is reasonable, I think it’s highly unlikely any such plan will get adopted in the foreseeable future. The reason for this is it would require the federal government to make many other adjustments. The most important one being reigning in government spending. I don’t expect drastic changes anytime soon. What I do expect, however, is incremental changes to the tax code. This will gradually increase the level of complexity of filing income taxes to an even higher level, which will continue to make knowledgeable tax professionals even more valuable.

Leave a Comment

Filed under Taxes

Leave a Reply

Your email address will not be published.