How much are you really paying for tax preparation?
What if I told you there was a hidden fee in your tax preparation bill. This hidden fee costs you serious money every time you file your taxes. This hidden fee shows up even when you prepare your own tax return. And it is totally avoidable. They sneak the fee in because you never see it and therefore never complain about it.
The hidden fee is hard to identify. It doesn’t show up as a line item on your accountant’s invoice or the online software payment page. Yet the fee digs hard into your wealth.
This same hidden fee looks different when you prepare your own tax return than from a professionally prepared return. The best way to expose this usurious fee is to handle it separately from how it is applied to DIY tax preparation and professionally prepared return.
DIY Tax Preparation Hidden Fees
There are numerous online tax software packages to help you prepare your own tax return. Some are very expensive, charging more than low-cost tax offices. And they still have the same hidden fee the expensive software charges!
By now you might have figured out the hidden fee is overpaying your taxes. While it is understandable a DIY tax preparation can have problems because you don’t understand the tax code as well as a professional, it is good to know what it is really costing you when you file your return. Before you toss in the towel and hire a tax pro you will want to read how this hidden fee applies to DIY tax preparation and how even seasoned tax pros can be hammering your wallet with you none the wiser.
Should you prepare your own tax return? It depends. If your return is simple, you are comfortable with the computer and filling in tax forms, you are probably okay. Most DIY tax software has ample Q&A to help you file an accurate return.
However, no software in the world can point out every issue. Sometimes the issue deals with money outside the tax return or affects multiple tax years. Software is no substitute for tax knowledge and experience.
There is a simple way to determine if you need a tax pro. If you have a small business or own income properties you probably should hire the professionals unless you can answer these three questions:
1.) Do I understand the tangible property rules and know when to deduct rather than depreciate? At what level must I depreciate? And, do I know what election to make so I survive an audit?
2.) Do I understand the repair regulations? What is the limit? And the rules surrounding this juicy deduction? Do I understand the election allowing me to deduct, rather than depreciate, up to $10,000 of improvements per building? Do I understand when a roof or other major repairs can be deducted rather than depreciated?
3.) Do I understand the Qualified Business Income Deduction? Do I understand the rules surrounding the definition of a “trade or business”?
If you can intelligently discuss the above questions you can prepare your own tax return with a business and/or income properties. If not, you need a pro. (Might I suggest you become a tax pro if you can intelligently discuss these issues.)
Since many elections that save you massive amounts of money require the election to be claimed on an original and timely filed tax return, it is important to get it right. There are no amended returns to fix some problems, you just pay the extra tax.
Wages, itemized deductions, interest and dividends have fewer issues. Tax software handles most issues revolving around these items well. If you have complex interest expense issues and don’t understand interest tracing you might want to try a tax pro until you do understand the issues.
Before we leave the DIY arena I want to talk about which tax software to use. The big names have become so expensive while you do all the work you would be better off going to the cheapy deluxe tax offices because they are cheaper (and at least they do the work). There is one DIY software I recommend. This software is used in over 64,000 tax offices and had a hand in the original software the IRS used when e-filing was starting out. It is the same software I use in my office. The best part is they have a flat $25 fee, including as many states as you want. That is by far the best deal in DIY software currently. And for full disclosure, the link in this paragraph to 1040.com is an affiliate link.
Tax Professional Hidden Fees
It is understandable when a lay person doesn’t understand the tax code well enough to get all her deductions. But when you pay good money to a pro it is downright insidious!
Let me give an example from my tax office earlier this very tax season:
A new client this past week had her tax return prepared by one of those $95 preparation fee outfits last year. My fee this year bumped up against $300, but I was cheaper.
Moral of the story?
1.) Experience matters.2.) The lowest fee isn’t the lowest cost to you.3.) Don’t hire people who take shortcuts.
This story begs the question: How do I know I have a good tax professional?
First, you can’t prepare a quality tax return for under $200. I know, I know. I can hear the vitriol already. But it is true. Low cost returns are prepared by data processors. They have the same skill sets as someone preparing their own return. In other words, they plug numbers and hope the computer got it right. Again, for simple returns this might be fine. But, as we saw above, as soon as even a modest complication enters the scene issues can arise that the data processor can’t handle.
The next step is finding a tax professional who can handle your tax issues and has a reasonable fee. A good tax professional, in my opinion, spends time with you AFTER the return is prepared. The before the preparation meeting is more about data processing; the meeting afterwards is about saving you money. Probably more money than you paid said tax professional. In effect, really good tax professionals are actually less than free since they return more tax savings and wealth building advice than you ever pay her.
So, where do you find these unicorns, tax professionals that know what they are doing with a reasonable fee? I have some ideas to increase your odds.
I have published on this topic before. These are two articles I strongly recommend, if I can be self-serving in the recommendations:
Not every tax professional is good at every aspect of tax law! For example, I avoid ex-pat returns like the plague. It’s not that I can’t do them; it’s that I don’t want to and don’t do enough to be good at it. Good tax professional are honest and admit their limitations. A tax professional too eager to get your account without first knowing the client (you) is guilty of one of my favorite saying:
Prescription before diagnosis is malpractice.
And it is.
Before you start your hunt for a tax professional I have an added suggestion. People with simple tax returns and older people (many times with simpler tax returns) might want to consider the Volunteer Income Tax Assistance (VITA) program. This tax preparation service has no cost to you for preparation of your return. They handle simple returns only, but many of the preparers came from the professional ranks and are retired now and don’t want to sweat as hard as they did in their traditional working days. If your return is too complex for the VITA program they will tell you. Then you are back to finding a tax professional on your own.
When looking for a tax professional you need to ask questions. Price is not the first question! It is the last one. You want to know if the supposed tax professional can push a 1 up against a 2 in an accurate way.
A good place to start your accountant search is by asking people in a similar situation as you are. If you have income properties, ask other income property owners who they use as a tax professional. Business owners should do the same. If you have multiple state issues you certainly need to find someone in the same boat you are because not all tax professionals handle out-of-state or multiple state tax returns.
This blog also has a list of tax professionals accepting new clients. It might be a good place to start your search. If you are a tax professional looking for more clients, use the contact page of this blog to see if we can include you on the list.
Always ask questions? If you feel uncomfortable, leave! You are going to spend serious time with your tax professional if they are good because they are going to save you a pile of money AND help you grow your wealth.
You can’t avoid the risk of the hidden tax fee. Whether you DIY or hire a tax professional, the risk is the same. My hope is that this short guide removes the bulk of that risk and puts serious cash into your pocket.
Tax professionals and clients, use the comments section to share successes and failures related to tax preparation. Your story is important in helping the entire group (our tribe, if you will) crowdsource the problem and solutions.
Until next time, keep your cash in your wallet.
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Living a frugal lifestyle sometimes lends to a false sense of security. We take all the financial precautions to increase our savings rate and invest in broad-based index funds. Before long the net worth starts reaching for the stars and we feel good about ourselves.
Now, we decide, might be a good time to get a second car or trade for a new one. Moving to a smaller home, across town or to another state or country, sounds tempting and easy to do with your nest egg growing faster than you are spending.
Your habit of caution is well defined. There will be no stupid tax in your future! Careful planning leads to good decisions. You look before you leap.
Then it happens and you never even saw it coming. You paid a stupid tax without even realizing it was there.
How the Government Robs Smart People
Smart people know how to avoid spending half their income on taxes. They fill their retirement accounts and use index funds for non-qualified accounts to keep the tax burden low. Using the tax code can really put a dent in your income tax liability. But the government has insidious ways to pry your hard-earned cash from your wallet.
Selling an old car and buying a new or newer vehicle has an obvious hidden cost: sales tax. When you sell your current vehicle the government collects some coin from the buyer; when you buy a replacement vehicle the government collects sales tax from you. In Wisconsin, where your favorite accountant lives, the sales tax is 5% with most counties tacking on a ½% or more. (I am aware a few counties have a 5.6% rate, but we are trying to keep this discussion clean.) If you buy a $10,000 car you are required to pay at least $500 in sales tax, more in most counties. The value of the car hasn’t changed, but your net worth took a 5% ding on the purchase price. New vehicles are even worse with the higher selling price and non-tax fees crammed down your throat by the dealership.
Buying a piece of real estate is the worst. We will use your favorite accountant’s state in our illustration.
Sales tax isn’t due on the purchase of a home, rental property, land or commercial property. (Can you imagine paying sales tax on a $400,000 home?) There are far worse things than sales tax when it comes to purchasing/selling real estate.
Local governments love when real estate changes hands. In Wisconsin there is a $3 per $1,000 transfer tax. Don’t forget title insurance and both the buyer and seller get a bill.
As a seller you pay realtor fees or pawn your property pro se. If you go it alone you will invest time and money advertising the property and running to show the property. You still need an attorney (and last I checked they still invoice for their time) to handle the legal documents when you have a buyer.
Rather than bore you with the myriad fees associated with real estate I will stop here. All you need to know is real estate, as the buyer or seller, has lots of fees/taxes connected to the transaction.
The transaction fee is the most voluntary tax of all. The more you spend the more you pay.
Reducing spending and saving/investing a majority of your income has many financial benefits. We hear plenty about reduced taxes based on retirement accounts. What none of this savings rate considers is the amount of money wasted on merely the transaction.
Taxes are not the only culprit! Sure, the government has its hand out whenever an asset transfers. But so do sales reps, attorneys, and (gulp) accountants. Everybody gets a piece of the action. You have no guarantee on how the new asset will perform for you. The rental property could sit vacant; the new car could be a lemon. But all the, ahem, professionals are getting paid. If you ask me to consult on a transaction know up front I am the only guy in the room guaranteed a profit.
Reducing the Tax Grind
Taxes will consume over half of everything you earn in a lifetime if you are not careful. Income and sales taxes are only the beginning. Payroll taxes take a bite and realized capital gains put a grin on Uncle Sam’s face. Before you blink, when is the last time you filled the tank on the car and thought, “Oh yeah, I just paid an excise tax.” Excise taxes are everywhere and hard to spot for a reason. It makes it easier for the government to get more of your wealth.
Property taxes are relentless. If you rent the landlord adds the property taxes to your rent; it’s built in. If the landlord didn’t include this major expense she would be broke quickly and the new landlord will not be so lax.
And did you forget you pay corporate taxes, too? You do. Corporations include their tax liability in their cost structure and pass it along to customers. The end user get stuck holding the bag.
Even when you die the government takes a slice in the form of the estate tax. It never ends even if you do!
You can fight back and regain control of your financial future. We have discussed visible (income, et cetera) taxes at length in the past. Now we want to gut the terror of the hidden tax: the transaction fees.
Fee’d to Death
When a simple phone bill has more individually listed fees than you actually make phone calls it is time to consider fees, transactions fees and how they affect your wealth.
We will focus on the two big ones: real estate and vehicles. Of course you already know if you increase your savings rate you will automatically reduce the transaction fees chewing into your life. Buy less stuff; pay less sales tax. You understand the concept.
Cars are a different story. Transportation is a necessary part of life. Even people who bike and walk everywhere they can frequently also own one or more vehicles. And each vehicle owned is a wasting asset.
The more often you buy a vehicle the more often you pay the stupid, ah, hidden tax. If you buy from anyone other than a “for sale by owner” there will be a profit built into the price. This doesn’t make the seller a bad person, just a business person who will survive.
No matter who you buy from you will pay a sales tax. Every sales tax paid is an instant reduction of your net worth. I have a powerful allergic reaction to any event that molests my net worth. There are times I come out swinging it is so bad.
There are two things you can do to massively reduce the transaction costs with vehicle ownership: buy as few vehicles as possible over a lifetime and pay less for the vehicles. Finding the lowest priced reliable vehicle to get the job done for the longest period of time creates the greatest savings. When I buy a car it will be in the family for a very long time. Most of my vehicles are purchased 2-5 years old and I run them for another 15-20 years. I don’t care what they look like! They only leave the family when they no longer can do their job.
A typical sale of an auto in my household is purchased by a local kid looking for a vehicle to enter into the local demolition derby. “Gi’me five hundred bucks kid and this beauty is all yours.” They buy it every time.
You may also consider forgoing vehicle ownership. Ride sharing and public transportation coupled with a good bike can keep transportation costs low. For those few times you need a vehicle for a longer trip I suggest renting. There are still transactions costs, but they tend to be minor in these situations compared to auto ownership.
The other big purchase that chomps a serious chunk out of your net worth is real estate. It drives me crazy when I see clients think they can trade houses like day-traders trade stocks. Of course you can make money flipping houses, but the transactions costs will kill you. Remember who is always guaranteed to turn a profit: the professionals (sales rep, et cetera). One bad deal and it all goes south quick.
Before someone points out I flipped a few houses over the years I want to point out I never went into an investment property with the intention of doing a quick sale for some easy greenbacks. We bought many properties and improved them all. If a rundown property cleaned up nice and we were offered a price we couldn’t refuse, we didn’t refuse.
I own homes like I own cars: for a very long time. I’ve lived on my current farm for 22 years. Before that I owned a home in town and before that I owned a mobile home because I didn’t want to live with my parents anymore. As far as I’m concerned, the mobile home was a vehicle (it has a license and everything) and is a wasting asset. The home in town was nice, but I always wanted to move back to the country where I could raise animals and till some land.
Warren Buffett still lives in the home he bought in 1958. Smart man. Bet he has money.
I’m not telling you you can’t buy a car or a property. If you want to own income property you have to buy it first. There is also nothing wrong with owning your residence. All I am pointing out is that you want to own as few of these big assets for personal use over your lifetime. Doing this one simple lazy thing (not buying/selling/trading your car/house on a regular basis) could increase your net worth by a million dollars or more over a lifetime if invested in an index fund.
Or, you can keep doing what you always do. My brethren in the legal and sales fields are happy to take you money.
So am I.