Double Take on Taxes

Guess who said, “The hardest thing in the world to understand is the income tax”? That would be Albert Einstein. Yep, Mr. Theory of Relativity himself. It has to make you wonder how the rest of us are supposed to manage. And the tax code has only gotten more complex in the years since Professor Einstein died.

It’s no wonder so many of us have a tough time understanding the many, many details of our federal income tax returns. Several years ago, The Wall Street Journal reported that the Treasury Inspector General found that the Internal Revenue Service (IRS) gave incorrect and insufficient advice 73% of the time. In response to this article, the IRS countered that it was only wrong 50% of the time! Half the time they give advice, they admit that it’s incorrect! This translates into billions of dollars overpaid in taxes by millions of Americans.

For most people, taxes are the most expensive item they pay each year. In fact, it’s usually well into April or May of each year before Americans reach the point that they stop working for the government and are actually working for themselves. All funds made before that date would, percentage-wise, be owed to the IRS. Because this represents such a large part of our earnings, doesn’t it make sense to get a second opinion or additional counsel for how much you turn over to the federal government? We’re willing to drive across town to save a few dollars for something on sale, but frequently with taxes, we just assume that anyone who prepares and files taxes for us is doing so correctly and getting us the lowest bill legally possible.

Money magazine conducted an on-going study of tax preparers—one that was done eight times in a ten-year period. Their research showed beyond any doubt how often mistakes can and are being made by tax professionals in preparing income tax returns. In the study, the same client’s financial profile was sent to 50 seasoned tax professionals for their review. It was to be used to complete the family’s tax return. The table below shows the results from the study.

When I saw the results, I could hardly believe it. The results from 1990 are especially shocking. The amount of taxes owed range from $6,807 to $73,247, again, for the same client. That’s an incredibly large difference in tax bills. On the one hand, you certainly do want to pay what you owe. On the other hand, how much do you owe? My personal opinion is I want to pay the smallest amount of tax the law will allow. As you can see, there seems to be a lot of confusion finding that number.

That confusion is costing tax payers millions of dollars in overpaid taxes a year. The startling results from their previous study prompted Money magazine to conduct a similar survey. They sent a hypothetical financial profile to 50 preparers picked at random from the Yellow Pages in Atlanta, Minneapolis, Philadelphia, Seattle and San Diego. All 50 preparers were given the same ten questions to answer. The results from this experiment were as shocking as the previous study. Of the 50 preparers, none of them got all ten questions correct and only 34 got at least half of them right.3 Yet another case for the argument to get a second opinion on your tax return. The response from Money magazine at the conclusion of the study said it all: “The implication for you (the taxpayer) is obvious. Chances are your return is so riddled with errors that even if it’s one of the 48% that will be handled by a professional tax preparer, you can figure you are paying 25% too much income tax.”

Kevin McCormally of Kiplinger’s Cut Your Taxes explains the process of recouping some of the money you may have overpaid in the past. “You have three years to amend a tax error,” he says. “An amended return is filed on Form 1040X and must be filed within three years of the filing date for the tax year in question. Be sure to use the tax rates for the year of the return you are amending. Send the amended return to the IRS Service Center for the area you now live in, even if the original return was filed elsewhere.”

When large returns are at stake, most taxpayers will file amended returns. But some worry that an amended return will trigger an IRS audit. The IRS says this is not so. Most tax experts agree that amended returns do not usually trigger an audit, saying that most changes get no more scrutiny than if you made the claim on the initial return.

The good news about getting help for your tax returns is that you don’t have to go from accountant to accountant, asking questions and comparing answers. There are quite a few companies that will review your returns for the past three years for free. The catch is that they work on a commission basis, allowing them to keep a portion of whatever overpaid money they identify, sometimes as much as 40%. But the way I see it, the money was “lost” to me already, so anything I get back from one of these reviews is more than I had before.

Another benefit of these companies is that they will guarantee in writing to back up their corrections in a tax audit at no additional charge. They will also work with your accountant to help him/her not repeat the same mistakes in the future. This can save you many, many dollars on future filings. To learn more about these type of companies, go to ForwardFinancialGroup.com. As proof of their services, they claim that six out of ten small business returns are wrong, and that, once corrected, businesses receive an average refund of $6,000-$10,000 after reviewing three years’ worth of returns.

Another huge tax loss area is the yearly tax refund. And for many of my clients, they are elated to receive a tax refund. According to USA Today dated March 23, 2006, John Waggoner states that the average tax refund for 2006 was $2,379 and three out of four people got a refund. Although a tax refund is popular, it’s really a loss. A refund is paid as a result of you overpaying your taxes throughout the year, usually through payroll deduction. The IRS is simply giving you back your overpayment without any interest attached. If you were dealing with a bank, you wouldn’t give them your money without expecting to get some interest paid back also. To prevent overpaying your taxes, I generally suggest to my clients to increase the allowances on their W-4 form. This will, in turn, reduce the withholding from your paycheck.

People always seem hesitant to adjust this common mistake in fear that they will have to pay at the end of the year when the allowances I’m suggesting they take are larger than their family. I find that people are confusing dependents with allowances. You claim your dependents on your Form 1040 when filing your taxes for the previous year. The W-4 form asks for allowances that would reduce your tax bill for the coming year. Most people only claim themselves, their spouses and children as allowances. If you itemize your return, you can also figure in mortgage interest deductions, charitable giving and child credits. For a complete W-4 worksheet explaining possible allowances, ask your employer or go to IRS.gov to review one.

I often have clients ask me what to do if they owe back taxes. I always remind them that I am not in the tax consulting business, but I do recommend that their first step should be to talk to the IRS. They offer several options and remedies to help people in this situation. One of the options the IRS does not frequently present is Form 843, which allows you to file for an abatement refund of penalties and interest on back taxes after they are paid. Very few people know of this option, and yet it can help you greatly. You have two years to file for the abatement refund after paying the year in question completely off. If you owe taxes on several past years, you can file a Form 843 each time you pay off interest and penalties for a given year and have the abatement applied to the remaining taxes owed to help pay them off even faster. The form does ask for a reason for the late payment and I recommend being completely honest with your answer. If you didn’t have the money at the time, just tell them and turn in the form.

As Ben Franklin supposedly said, “There are only two things in life that are certain: death and taxes.” If you have a relationship with Jesus Christ, the eternity part of that equation holds no fear.

For Information on ways you may be able to obtain money you may have overpaid you can visit www.forwardfinancialgroup.com.