Before becoming a tax accountant, I always prepared my own tax returns. Admittedly, my personal finances were not very complicated, so doing my own taxes was never really a big deal. Now that I know much more about tax law, I still believe that most taxpayers can complete their own tax returns, that is, if they are patient enough and willing to do a little required reading. There are some aspects of federal taxation, however, that are definitely tricky to understand. When dealing with these types of tax issues, I would recommend getting the help of a tax professional, preferably a CPA.
Below are two aspects of tax preparation I think most taxpayers should be able to handle on their own. And then after that, I've listed two tax activities that need, I think, some professional assistance.
Tax issues you can handle on your own
1. Completing your Form 1040EZ, 1040A or 1040
As an individual taxpayer, you'll be filing one of the three forms listed above. Form 1040EZ is the simplest of the three forms, and should be used if all you have to report is income from a job, interest income from your bank account(s), and maybe some unemployment compensation. If your situation is more complicated than that, you will need to use either Form 1040A or Form 1040 (the latter being the most complicated of the three).
Will it be easy? It should be relatively simple to decide which of the three forms to file. For starters, pull out a copy of your prior year's tax return. Has anything changed in your life from last year? If not, you can file the same form and just update the numbers for the actual year's income or expenses. If you have never filed before, or if your financial situation has changed, you can look at the three forms listed above online at the Internal Revenue Service's (IRS) website, and browse over them briefly just to get an idea of what the IRS is looking for you to report to them.
2. Completing Schedules A and B
Sometimes you will have to complete supplemental forms, called "schedules," and attach them to your Form 1040A or Form 1040 (Form 1040EZ does not allow the use of any of these supplemental forms).
Will it be easy? I believe the following two schedules are easy enough for most taxpayers to complete on their own:
Schedule B. You will most commonly need to use this schedule if you had taxable interest or ordinary dividends greater than $1,500 in the year. This schedule is only one page long, and is relatively simple to complete. It can be attached to either Form 1040A or Form 1040.
Schedule A. You will need to use this schedule if you decide to itemize deductions instead of using the standard deduction provided by the IRS. This schedule is two pages long (though most people won't have to complete page 2. It is best to go line by line, either following along with the instructions at the end of the form, or answering all the interview questions asked by the tax preparation software you may be using. This schedule is slightly more detailed than Schedule B, and you can only use it with Form 1040 (not 1040 EZ or 1040A).
What are some possible pitfalls? For both #1 and #2 above, it is possible for the average taxpayer to miss reporting an item of income or to take, or fail to take a deduction against taxable income. This will most likely happen if you do not read the instructions that come with the forms and schedules carefully, or if you just didn't really understand what was being discussed.
What resources are available to help you? You could complete the above tax forms manually, but my personal recommendation is to use Turbo Tax - Tax Preparation Software. Their website offers everything from a free version (for simple returns), on up to a very robust version for completing your business tax returns. Pick the version from their website that is best for your situation. Even if you have to use one of the paid versions of their software, it should still save you money over using a tax professional.
Additionally, in order to help you understand some of the tax questions on the forms you will be completing, you can use the "Help" section available within Turbo Tax itself, or refer to the following helpful websites:
* The official website of the Internal Revenue Service (IRS): http://www.irs.gov/
* H&R Block's Tax Tips and Calculators: http://www.hrblock.com/free-tax-tips-calculators/all-tax-tips.html
* The Jackson Hewitt Tax Help Center: http://www.jacksonhewitt.com/Resource-Center/Tax-Topics/
Tax issues that may require a professional's assistance
1. Completing Schedule C
Schedule C is used by self-employed individuals to report their business income and expenses. It can only be attached to Form 1040. I would recommend using a tax professional to complete this schedule -- at least the first time through. After that, you could use the prior year's professionally prepared version as a guide to complete the form on your own in the following year.
Why is it difficult? You will need to carefully gather an appropriate amount of documentation in order to complete this schedule correctly. It is quite easy to misunderstand allowable business deductions and limitations on those deductions. You will also need to complete Schedule SE in conjunction with Schedule C in order to find out how much self-employment tax you owe the government. And you will need to complete Form 8829 if you are taking a home-office deduction. These two additional forms present a few additional complications of their own. Completing Schedule C will also require an understanding of slightly more complex tax issues such as, the "at-risk rules," limitations on losses, methods of valuing inventory, and claiming vehicle expenses.
2. Completing Schedules D and/or Schedule E
Schedule E is used to report income from rental real estate, royalties, partnerships, S corporations, estates, trust, REMICS and the like. Schedule D is used to report capital gains and losses. Both of these schedules can only be submitted with Form 1040.
Why are they difficult? The first section of Schedule E will ask you to list your income from rental real estate. The rules about what is "rental" real estate and what classifies as allowable income and expenses are slightly involved. The second and third parts of this schedule are where you list income from partnerships, s corporations, estates and trusts. These numbers will be taken off of the "K-1's" you will receive from these entities after the tax year ends. However, not all the income on the K-1's gets reported on Schedule E. Some of it may need to go on page 1 of Form 1040 instead. It is not always easy to understand the classification rules related to where and how to report this income.
Completing Schedule D, on which you report capital gains and losses, will require you to understand how to calculate recognized gain and loss amounts, and how to apply the basis rules for purchased property, donated property and inherited property (this all gets pretty messy). Additionally, you will need to be aware of the rules for losses that are not deductible (e.g., in the case of wash sales or related party transactions), and you may need to apply the depreciation recapture and loss carryover rules as well.
Why use a professional? As of Jan. 1, 2011, the IRS is requiring anyone who is paid to prepare a tax return to register online with them. You do not need to be a CPA to register with the IRS and prepare returns. However, when you are dealing with complicated tax issues, it is probably a wise bet to use a CPA or other tax professional who has been required to comply with extensive education and experience requirements and has a higher level of financial expertise.
Where can you get help? You can use the American Institute of CPA's taxpayer friendly website to help you to locate a qualified and licensed CPA in your state: http://www.360taxes.org/Preparing-My-Taxes/Choosing-a-Tax-Preparer/Find-a-CPA-in-Your-State.
Jan Fleming is a tax accountant and CPA.
Browse your computer here
