Tax law changes, expanded electronic services from the Internal Revenue Service, simplified tax filing rules for certain forms and an expected increase in total returns mark the start of the 2005 tax filing season.
While the total number of filers has remained about the same for the past two years - at about 132 million - the rebounding economy and lower unemployment rate indicate a significant increase in filers, according to observers. The IRS anticipates 133 million filers this year, while Liberty Tax Service's John Hewitt predicts up to 2 million additional filers.
"About 62 percent of filers pay a preparer to do their returns," he observed, "so there should be a million more paid returns if everything else goes the way it normally does."
Although the IRS has mailed 29.5 million tax packages to American households, it projects that the number of individual taxpayers filing their taxes electronically will surpass 50 percent for the first time.
"In 2005, we expect more than half of all individual tax returns will be filed electronically. E-filing is fast, secure and reliable. Taxpayers who e-file will get their refunds in half the time," said IRS Commissioner Mark W. Everson.
Taxpayers who use IRS e-file have a higher satisfaction rating than those who use paper returns, according to the American Customer Survey Index, which rates private and public sector service industries.
The IRS has simplified filing for many by increasing the number of filers eligible to use the simpler versions of Form 1040 and Schedule C. The income limits for using Form 1040EZ and Form 1040A will increase from less than $50,000 to less than $100,000. The change in the threshold will make 1.6 million more taxpayers eligible to file the 1040EZ or the 1040A. Last year, approximately 18 million taxpayers filed Form 1040EZ and another 24 million filed Form 1040A.
In addition, the limit on business expenses for self-employed individuals using Schedule C-EZ will increase from $2,500 to $5,000. This will allow 500,000 more small business owners and self-employed taxpayers to use the simpler version of the expense form. The IRS calculates that this will amount to a savings of 5 million hours of paperwork burden for small business taxpayers.
Ringing the changes
The tax law changes should not present an overwhelming problem for preparers this season, according Bob D. Scharin, editor of Warren, Gorham & Lamont's Practical Tax Strategies.
"Even though there were two major pieces of tax legislation last year, not that many provisions actually took effect in 2004," he said. "And some of those that did are extensions of provisions that tax preparers were accustomed to in prior years - for example, the special deduction for educators was scheduled to disappear at the end of 2003, but it was extended."
"Over the last few years there has been a proliferation of worksheets, so a lot of computations are made off the form itself," observed Scharin. "That trend continues with the sales tax deduction. It's available to people who itemize and choose to deduct sales tax rather than state and local income tax."
"Taxpayers can deduct the actual tax paid based on their receipts, or use tables based on the state they live in, the size of their family and income level," he said. "The tables only have figures for the state sales tax, so if they live in an area that also has a local sales tax, they will need to use the worksheet."
Another new worksheet is the tax computation worksheet, used instead of the tax rate schedule for individuals with more than $100,000 in income, noted Scharin.
"Even for provisions that haven't changed, tax preparers should be aware of changed circumstances of their clients," he said. "Counties in 42 states were declared disaster areas in 2004, so there are likely to be many more taxpayers eligible to claim casualty loss deductions who may not have in prior years."
Additionally, Scharin said that practitioners should be aware of the special tax provisions for members of the armed forces, including the changes in combat pay exclusion for purposes of the child tax credit.
A less-silly season
Timur Taluy, vice president of Oxnard, Calif.-based FileYourTaxes.com, predicted an easier season for preparers. He pointed to the elimination of the pre-May 5 and post-May 5 categories for capital gains, which complicated Schedule Ds last year, and the growing number of states that follow the federal depreciation system.
"A lot more states are conforming to federal depreciation regulations now," he said. "For those states, you only have to keep one set of depreciation books."
Taluy predicted that taxpayers will continue to seek paid help in preparing their returns.
"Last year there was an increase in preparer-prepared returns," he noted. "That trend will continue because a lot of taxpayers are getting into dividend positions, and home ownership is increasing. Anything that complicates the return drives taxpayers to look for professional assistance."
The refund anticipation loan market will continue to grow this year, according to Wayne Novitch, who owns five Jackson Hewitt offices in northeastern Pennsylvania. "Our HELP was strong in December," he said.
HELP - Jackson Hewitt's Holiday Express Loan Program - gives loans of up to $575 based on the amount of refund the taxpayer is projected to receive, how much was withheld during the year and the filer's creditworthiness.
"But preparers who offer RALs should make sure they tell the taxpayer that if they pay for the return up front they can get it e-filed for free and have a direct deposit made into their checking account," said Novitch. "They can get the direct deposit from the government in 11 to 17 days, or if they want the IRS to issue them a check, it will take 17 to 24 days."
The big choice
The most significant tax law change affecting individual filers is the state and local sales tax deduction, according to Bob Erickson, senior technical advisor for tax forms and publications with the IRS.
"For the first time since 1987, you'll be able to choose to either deduct state and local income taxes, or your state and local general sales taxes," he said. "But you can't deduct both. On Schedule A, we've added not a new line, but two check boxes, one to indicate which of those taxes you're choosing to deduct."
Although the form is clear that the taxpayer is limited to a deduction for either the state income tax or the sales tax, some observers predict that confused taxpayers will deduct both.
"The confusion will be good for preparers, since it will spur taxpayers to seek professional assistance," said Liberty's Hewitt.
With nearly a third of the $30 billion paid out under the Earned Income Tax Credit program going to those who don't deserve it, the IRS is increasing its compliance efforts.
"Close to 65 percent of EITC returns are prepared by a third party," said IRS spokesperson Nancy Mathis, "but the error rate is the same as when it's prepared by the individual."
To aid tax professionals in navigating the complex EITC rules, the IRS has developed a special Web site, www.eitcfortaxpreparers.com. The site reminds preparers that it is their responsibility to follow due diligence requirements and avoid EITC errors.
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