Cleaning Up the Mess Left by DIY Tax Software
IMGCAP(1)]More and more taxpayers are turning towards do-it-yourself tax software to prepare and file business and individual income tax returns.
With every passing year, our offices receive an ever-increasing number of calls asking for help fixing previously self-filed returns. Consumers of these products are beginning to treat tax preparation software as virtual tax return preparers. As the IRS has focused on increased regulation for paid providers of tax return services, I believe the Service’s scope should include tax preparation software providers as well.
The security of taxpayer accounts and personal information has been a top priority of the IRS for e-file providers since the electronic filing program’s inception. Publication 4557, Safeguarding Taxpayer Data, and Publication 4600, Safeguarding Taxpayer Information were published to provide guidance and best practices. However, in 2015, Intuit’s TurboTax systems were reportedly hacked, leading to many fraudulent returns being filed without the taxpayers’ knowledge.
[Editor's Note: According to an Intuit spokesperson, based on an internal analysis and validation from an outside third party, the company determined that there was no evidence of a data breach. Last year, Intuit reported it saw an increased occurrence of stolen identity refund fraud where a fraudster acquires personal information/credentials outside of the tax prep process and uses that info to file a fraudulent return.]
The repercussions of the fraudulent returns left fraud victims having to manually file their tax returns, file police reports detailing possible identity theft, and monitor their credit reports for any other signs of their information being used. Despite the security breach, no penalties were imposed against Intuit. The company was only instructed to prepare a list of changes to reduce tax fraud by the next filing year.
Tax preparation software providers need to apply the same strict data-handling guidelines to self-preparation tax software as do the professional tax preparers.
Another significant issue with do-it-yourself software is the consumer’s reliance on it to do the impossible and apply the voluminous amount of tax law to their individual scenario. Without a firm grasp of the ever-changing tax law, individuals are relying heavily on the automated prompts within the system to help guide them, further creating the illusion that preparing and filing income tax returns is simple in all cases.
Granted, a tax return may be simple, and the software utilized may be sufficient, in some cases. However, even in straightforward scenarios, costly mistakes can and do happen. A client of ours, for example, forgot to enter the city tax that was withheld from them, costing them approximately $4,000 while self-preparing a very simple return. Additionally, what most fail to realize about tax audits and proceedings is that the burden of proof, unlike the legal system, fall on the taxpayer to show the reason why certain deductions were taken or key information was omitted from the return. Consumers of these tax products need to be reminded that relying on prompts from the software does not constitute a viable defense.
Another case involved both a business and a personal income tax return, and arose from the taxpayer’s limited knowledge of Schedule K-1s, the IRS’s ability to cross reference documents, misclassifying large expenses, and misrepresented 1099 filings. The taxpayer had not included Schedule K-1’s on his personal return after preparing his own business’s return. The taxpayer failed to realize that the IRS operates on a matching system in which it matches third-party filings with an individual’s return. The mismatch of the K-1 that was present on the S corporation return, but not found on the client’s 1040, triggered a correspondence audit. In yet another example, the client incurred over $161,000 worth of penalties and interest over multiple years, and had to spend over $30,000 in accounting fees over a number of years, working with the IRS and states, to remove the incorrect penalties and amend six years of business and individual tax filings.
The cause? The client used self-preparation tax and payroll software, and assumed their company was correctly filing partnership and payroll forms for years. In fact, the client had been sending in payroll tax deposits, but not filing all of the forms consistently, omitting filing for the periods where no payroll tax was due. The client was unaware of a requirement that mandated taxpayers to file zero payroll forms. Since the IRS had not received zero payroll forms, the tax liability from prior periods was assumed for the periods with missing tax forms. Aside from missing forms, the client was also unaware that an employee had a certain type of visa status that exempted an employer from certain payroll taxes. Presenting this information helped to show that a payroll tax overpayment existed on the account, helping to reduce their penalties and interest.
Taxpayers should be made aware that the software they are using and relying on to prepare and file their taxes may not adequately report their tax liability to comply with tax laws. Furthermore, taxpayers may inadvertently be leaving more of their money on the table due to the automated software. ABC News recently showed a segment on how one family’s refund amounts differed when using do-it-yourself tax software, a storefront tax preparer and a tax accountant. Their highest refund was calculated by the tax accountant. The family admitted to having overlooked a key item within the tax software, which the tax accountant had found for them. By engaging in an open dialogue with a tax professional, the family was able to more than double their tax refund amount.
Until the IRS requires all tax preparation software providers be held to the same standards of paid tax professionals, we must continue to advocate for our clients and those burned by do-it-yourself software. It is up to us to remind taxpayers to seek professional help with their tax issues to avoid costly mistakes. The services of tax professionals may seem more expensive upfront than do-it-yourself tax software at first glance. To overcome this obstacle, it is important to showcase the value in choosing tax professionals who not only provide peace of mind, quality of service, and thorough investigation and resolution of their tax issues, but also perform in-depth tax research and perform representation services. As tax professionals, we need to keep the dialogue open with our clients and those attempting to navigate through tax laws on their own, and remind them of the value we bring.
Greg Freyman, CPA, CGMA, is the CEO and managing partner at Freyman CPA, P.C. in Westwood, N.J. He holds a bachelor’s degree in accounting from City University of New York – Brooklyn College and is a certified AICPA Chartered Global Management Accountant. He has been featured in Crain’s NY Business. He stays up to date on the latest developments in tax and accounting rules and regulations and is proficient in Spanish and Russian.