Tax preparation can look like a complex task if you go into the process unprepared. It takes time to gather records, understand deductions and eventually gather everything together to file your return. And once you have done all this, filing through a professional preparer can end up costing you a hefty amount if you are unprepared (I had to spend almost $300 on my return a few years ago). So what are some ways to reduce this cost?
Free filing Options
There are a variety of free file options for taxes that people can take advantage of if returns are fairly simple without any stock transactions or rental income. Even commercial preparers offer these and they are suitable for the majority of people filing taxes. The IRS has a specific program called the free file program which lets families earning less than $57,000 file their taxes for free in 2013.
While the free filing software won’t help you maximize your deductions you are generally better off claiming the standard deduction rather than trying to itemize unless you have a complex financial situation where you have a lot of non standard deductions, such as margin interest
Consider “hybrid” options
For those of us with more complex tax returns its sometimes not clear how to maximize the deductions that you claim at tax time. For example, you may not be aware, but under the tax rules, people that earn qualified dividends can choose to treat these as regular dividends in some situations. Why would you elect to treat dividends at a higher tax rate you ask? If you have significant margin interest deductions, you may not be able to claim all of the interest against your qualified dividend income, when it may yield you a more favorable tax outcome to do so.
Being able to analyze and optimize your tax situation based on factors like the above is valuable and in these situations it can make sense to get some professional assistance with your tax return. However with the fees for average preparer returns around $200, it helps to minimize how much you have to pay whereever possible.
To that end, its well worth considering hybrid approaches to file your tax return. In these situations you can actually prepare your tax return in the first instance and then have your tax preparer review and check this return for you. The advantage of this approach is that you pay far less then with a fully prepared professional return, but you still have the advantage of having your return reviewed by a professional.
You pay the professional for what they do best in assessing the return, and not for the cost of having them do all the manual data input of your return. I have used the HR Block Best of Both Service, which is exactly this hybrid approach. At a cost of around $80, its still more expensive than filing yourself, but certainly significantly cheaper than using a professional preparer.
Is it worth it to have a professional look at the return? Last year, I overlooked a couple of deductions which were caught by my H&R Block Best of Both preparer, which ended up netting me an extra $400, more than justifying the cost that I spent on the service.
Avoiding “other extras” from professional firms
Tax preparation firms often advance tax refunds to those desperate for cash. These loans carry very high fees and effective interest rates which aren’t necessarily obvious to most people that file their returns. The effective rate that you pay on the loan can often exceed 20-30% per annum. These types of products should be avoided at all costs. Its better to wait a few extra weeks for the money than pay such a high effective rate.
Some tax preparers also provide audit protection insurance, which you can purchase with your tax return. This provides the assurance that they will represent you in any audit with the IRS. The fact of the matter is that for the majority of tax preparers, the odds of being involved in a tax audit where you would actually require representation is fairly low and normally only arises where you have deductions significantly out of line with your income, or for which the IRS doesn’t have documentation.
Generally in these cases, you have to mail in some documentation in response which often clarifies the matter. In some exceptional circumstances, you may get called in to the IRS office and have to defend your return, which you probably should be able to substantiate better than a 3rd party could.
How do you generally prepare your taxes? Have you ever purchased “extras”?