More new tax laws, continued new e-filing mandates, an expected increase in total returns, and a delay in processing are certain to mark the start of the 2007 tax filing season.Recent changes in the tax law, primarily those involving three tax deductions - for state and local sales tax, higher education tuition and fees, and educator expenses - mean that the Internal Revenue Service will not be able to process some individual returns until early February. "We will not be processing any returns, whether they are filed electronically or on paper, that contain the extended tax breaks until early February," confirmed IRS spokeswoman Nancy Mathis. "We estimate the number of returns affected by this delay is approximately 930,000 returns out of 136 million returns we expect to be filed."
However, the number of returns affected by the delay will be small, according to Mathis. She urged taxpayers to e-file, instead of using paper forms, to minimize confusion over the late changes and reduce the chance of making extender-related errors on returns.
The state mandates will increase the percentage of taxpayers who e-file, according to Jo Ann Cummings, ProSystem fx Tax product manager for Riverwoods, Ill.-based CCH. However, she noted, "There will be some bumps as a result of the late passage of the extenders bill, and the fact that some states are still testing and have not yet issued the requisite schemas."
"[E-filing] may cause some problems," predicted Cindy Hockenberry, tax information analyst at the Appleton, Wis.-based National Association of Tax Professionals. "Whenever items are not on the tax form or not on the software, mistakes are made and some returns will have to be amended."
The 80 percent e-filing goal may not be reached this year, but it's not too far off, she suggested. "They may have to mandate it to get over the hump."
"There are always things that come up that people don't expect," she noted. "Charitable contributions are one area. Household items must be in good condition, and donors need substantiation. Some taxpayers may not be aware of the over-age-70-1/2 minimum distribution opportunity."
MORE FILERS AND THE PPA
John Hewitt, chief executive of Virginia Beach, Va.-based Liberty Tax Service, said that estimates call for an increase of nearly 2 million more filers this year, with an accompanying bump going to the paid preparer. Hewitt said that Liberty grew over 40 percent last year, and this year he expects 40 to 60 percent growth.
Meanwhile, the Pension Protection Act of 2006 has given a window of opportunity to do some significant charitable contribution planning for these individuals, said Kathy Tollaksen, a CPA at Midwest regional firm Sikich LLP. "These individuals may now withdraw funds directly from their IRA and transfer it to qualified public charities," she said.
The individual will not have to include the distribution into income for the current year. Although the individual will not be able to take the charitable deduction, the distribution counts towards the required minimum distribution. However, this is only available for calendar years 2006 and 2007 without any carry-over to subsequent years, she cautioned.
"The challenge this filing season will be to communicate with clients what is new for the 2006 return, and also what to look out for in 2007," said Bob D. Scharin, of New York-based RIA's Warren Gorham & Lamont's Practical Tax Strategies.
"Some things, like the energy credit or the hybrid car credit, will require the return preparer finding information and prompting the client to tell whether the expenditures were made. This is new for 2006, and is not something the preparer does every year," he said.
"Another change that could be problematic is the extension of the Kiddie Tax from under age 14 to under age 18," continued Scharin. "When the preparer is filling out the child's return, he has to ask how old the child is. Some clients might do their children's return on their own because they figure it's a simpler return. Those people may need to be alerted that the Kiddie Tax applies to their children."
Taxpayers who typically claim a charitable contribution deduction for cash donations need to be alerted that beginning in 2007, they need to be able to substantiate everything, not just contributions over $250, Scharin noted. "That means no deductions for cash thrown into the collection plate," he said. "People who make small contributions to their house of worship every week might want to wait and aggregate their weekly contribution and give it all by check at less frequent intervals."
He added that the extenders bill, passed after the filing forms were printed, will create problems for do-it-yourselfers, and may drive more of them to seek professional advice. "Some lines on the forms will have to do double duty, and it's bound to be confusing to some," he said. "And because of the processing delays, early filers will have to wait a longer time to get their refunds. The practitioner may want to warn his clients about this in order to avoid phone calls from clients asking, 'Where's my money?'"
For Alan Osmolowski, head of the tax department at regional New England firm Carlin, Charron & Rosen, the staffing issue requires the greatest focus. "Like many firms our size, this has been our biggest challenge," he said. "This past year we invested a lot more heavily in college graduates, and now we're seeing dividends. In terms of going into tax season, we feel better."
The firm outsourced about 2,000 returns last year, but will probably do it less in 2007, he said. "We'll continue to do it, although we'll probably do it less now because we have more staff, and we're using new technology to do the things internally that we used to outsource," he said. "For example, we used to send returns to India to bookmark. Now we're using scanning technology to do this."
Osmolowski uses both CCH's ProSystem fx Scan and Thomson's GoFileRoom. "We feel the tax flow will gain in efficiency in how we track and schedule work. It helps in maintaining morale," he said.
E-filing has accelerated over the past three years as a result of the state mandates, according to Lacerte senior product manager Jorge Olivarrieta. "As more states mandate it, the trend will continue. Most preparers and taxpayers know the benefits by now - the ability to know if the return has been accepted, and quicker refunds. Back six or seven years ago, people thought e-file would consume more of their time, but as the industry has improved the product, they're better able to handle the workflow. People have experienced the advantage in incorporating e-filing into the process."
Although Microsoft is expected to introduce its new Vista operating system, Olivarrieta doesn't foresee any problems. "We don't see a mass adoption by accountants in the middle of busy season," he said. "Nevertheless, we've been working with the beta version and are making sure the product can function within it."
For many taxpayers, the alternative minimum tax will continue to creep into the picture, noted Edward Marcum, tax services partner at Clifton Gunderson LLP, which has 55 offices in 15 states. "This will be of particular concern to people living in states with higher income and property taxes," he said. "As has been the case for many years, the tax law is a maze of tax provisions that are phased in, phased out and effective in many cases on only a temporary basis. For tax preparers, there will continue to be an emphasis on filing electronically, which entails moving the date on which the returns are completed forward, so preparers can be certain the electronic file is acceptable to the IRS."
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