Research

Podcast: Tips for filing your 2006 tax return

With tax returns due on April 16, we get an extra day to file this year. In a recent interview, Professor Charles Christian, director of the School of Accountancy at theW. P. Carey School of Business, shared some information that individuals should consider as they prepare their 2006 personal income taxes. A well-known tax researcher, Christian was appointed recently to a three-year term on the IRS Advisory Council. The council suggests operational improvements, offers constructive observations about current or proposed IRS policies, programs and procedures, and advises the IRS on particular issues having substantive impact on federal tax administration.

2007-03-28

With tax returns due on April 16, we get an extra day to file this year. In a recent interview, Professor Charles Christian, director of the School of Accountancy at the W. P. Carey School of Business, shared some information that individuals should consider as they prepare their 2006 personal income taxes.

A well-known tax researcher, Christian was appointed recently to a three-year term on the IRS Advisory Council. The council suggests operational improvements, offers constructive observations about current or proposed IRS policies, programs and procedures, and advises the IRS on particular issues having substantive impact on federal tax administration.

Knowledge: There may be an extra day this year to file your taxes, but that doesn't mean you have a lot of time left. April 16th is just around the corner. Whether you prepare your own taxes or have a professional do them for you, there are some changes you should know about them. Joining us to explain those changes and how the IRS is doing more to help do it yourself tax filers is Professor Charles Christian, director of the School of Accountancy at the WP Kerry School of Business.

Charles Christian: One of the biggest changes for tax year 2006 is a last minute increase in the alternative minimum tax exemption amount. The AMT is beginning to affect a significantly larger number of people each year and the exemption amount that had been increased was scheduled to expire. However, at the last minute in December of '06 President Bush signed legislation that raised that exemption amount to $62,550 that will save thousands of dollars for people who are subject to the AMT.

Knowledge: How would a person who is preparing their own taxes or more likely preparing their own taxes doing it by software, how would they realize and know how to deal with that?

Charles: It's included in all of the software as long as you update it. For instance, if you have Turbo Tax and installed it onto your computer back in December you should visit the Turbo Tax website. In fact, in Turbo Tax you don't have to leave the software, you can just ask the check for program updates and be sure to do that because some forms are updated and also any change in legislation, any last minute bill for instance would be updated.

Knowledge: So what do you think are some of the other changes that tax preparers and individuals filing taxes are going to be facing as they face the next round of taxes?

Charles: There are a couple. The personal exemption amount and also the amount given for dependence has been increased to $3,300 for tax year 2006. The standard deduction is up to $10,300 for married couples filing jointly. The exemption amount is also up for single individuals as is the standard deduction. The standard deduction varies depending on filing status and whether the taxpayer is blind or not so there is a long cable for the deduction amount.

Knowledge: What's the best advice you can give to someone preparing his or her own taxes?

Charles: I strongly recommend that tax payers who are doing their own tax return to get a copy of the publication 17. The publication 17 is available directly from the IRS website if you click on the individuals tab and then under tax information for individuals scroll down or just half way there is a link for publication 17 and you can download it. This is a really invaluable aid that covers many questions individuals might have. I hate to tell you this but its 295 pages long, but it's very well organized. Good table of contents and is perhaps the best free guide available.

Knowledge: Do you need to be CPA to understand it?

Charles: No the publication 17 is written in very readable and understandable language and is designed for individual tax payers. This publication is not designed for the professional. It is designed for the individual tax payer who is preparing their own return.

Knowledge: What in particular should individuals know about their software? You alluded to some of it by making sure they get the updates. Is there anything else, any caveats about using that?

Charles: There are a variety of different types of software. Some for instances are just actually on the web where you just turn on a Web site while others of course are software that you purchase and install on your own PC. And I would give a recommendation that individuals visit the IRS website because there is a free online filing program administered by the IRS for tax payers who have an adjusted gross income of less than $52,000. And by the way, that's a significant proportion of individual income tax payers. And there are a number of firms in collaboration with IRS are providing free online tax preparation software.

Knowledge: Is that something you would recommend for most individuals to do or does it give the impression that its easier to file your taxes and you may be missing things or doing things work that you do not even realize?

Charles: Well, it's true that if you get professional advice you may pick up some tax savings you would otherwise miss. And so maybe I can comment briefly about the role of paid prepares. There are a number of different kind of paid preparers and I think tax payers should choose very carefully.

The first is that a large group of unregulated sole practitioners who hang out a sign that they're a tax preparer and they'll prepare your taxes for a fee. But they're not regulated. The second is the large commercial preparers that are very good. They are the H & R Blocks and the Jackson-Hewitts of the world and they file an enormous number of tax returns.

The third category is the enrolled agent and this is a specialized tax return preparer that is licensed by the US Treasury and they take an exam and have a code of ethics and like I say, one notch higher. And lastly is CPAs and attorneys. Of course they are licensed and regulated and signed off on tax returns and you can be confident they are correct when prepared by a CPA or attorney.

Knowledge: Can you explain VITA and TCE?

Charles: The VITA program is volunteers who help prepare tax returns. There are a number of sites around the metropolitan Phoenix area where VITA chapters post and they'll even advertise in the newspaper when they are available. The law school here at Arizona State have a chapter.

They help individuals prepare their returns. There is also a program TCE which is the Tax Consultant for the Elderly. And the TCE program also does the same thing. You can find information about them on the IRS website and find the local chapters and their schedule of providing free tax assistance.

Knowledge: You mentioned something on electronic filing and you seem to be a proponent of it. It will cut down on errors, it is easier. Are more and more people really doing it? Do more people understand how to do it?

Charles: Yes, electronic filing has many advantages. Of course for many tax payers the reason they electronically file is they get their refund much faster. There are other advantages too. In particular, fewer errors in processing. As you know, if you file a paper return, it has to go an IRS service center where an individual manually types in or transcribes the information.

There are a few of the simple returns that have automated optical character recognition but most of the individual form 1040s are manually transcribed. Of course there are errors in that process. But now over a majority of the individuals are filing electronically. It was over 72 million filed last year and there was an additional eight million returns for business returned electronically last year.

Knowledge: Now, what about filing for an extension? For some people that seems like it would be a very complicated thing, or they're not quite sure how to do it. Is it something that a lot of people do? Is it something that is difficult to do; is it better if you have an accountant doing it for you?

Charles: No, you do not need an accountant, or a tax return preparer to file for an extension. You can easily do that yourself by filing the Form 4868, and it provides an automatic six months extension, that previously used to be a four month extension, by the way. And the form though is only an extension of time for filing the return; it's not an extension in time for paying the tax that is due.

So, it's an easy form to fill out, but it does require that you make an estimate of how much tax is due for Tax Year '06, and pay any balance due when you file the extension. But, this is far preferable to being late in filing your return. There are penalties for late filing, and for late paying, and you can easily avoid that late filing penalty by filing the extension. Directly from the IRS website under the tab for Individuals, is a link to extensions using Form 4868.

Knowledge: Do you think a lot of people are surprised that they have to pay even after they file an extension? Because I've talked to plenty of people who seem very surprised when they're told that, "Well, you still have to pay."

Charles: Well, you're right. I'm sure some people don't realize that the extension is only an extension for filing the return, not an extension for paying the tax. But, still you know, there's going to be a penalty, and interest charges if you're late paying. So, taxpayers are required to pay any balance due that they owe over and above their estimated payments, or their withholding by April 16 as it is for this year, because April 15 falls on a Sunday, the deadline is April 16.

Knowledge: You also mentioned changes in the Excise Tax. Do you care to comment on that?

Charles: Well, it's been litigation on this Excise Tax that had been charged on long distance telephone service, and there is now a program to refund individuals this Excise Tax that was collected. The way Congress decided to refund it is by giving Taxpayers a credit on their Federal Income Tax Return.

There is a standard refund amount that's new for Tax Year 2006 that varies between $30-$60, depending upon how many people lived in your household, and you don't have to calculate the actual amount of telephone Excise Tax that was paid. If in fact, you have the receipts, the telephone bills from the past, you can add up the actual amount of the Excise Tax that was paid and claim a credit for that using Form 8913. That issue is directly addressed from the IRS's website also.

Knowledge: So, you've paid your taxes, you got a nasty surprise, or a good surprise, whichever way, but what can you start doing now to prepare for 2007, particularly to say with withholding?

Charles: That's an excellent question, and this is the time of year, early enough in the year to make a difference to make sure your prepayments in this year '07 will cover your tax liability for when you file next year. On the IRS website, under the Individual tabs, if you scroll down, oh 3/4 of the way down on that page there is a link to the IRS withholding calculator.

And you put in information about 2007, and it estimates the number of Withholding Allowances you should claim with your employer. You can file a new Form W4 with your employer to adjust your withholding to make sure you'll be covered for '07. Similarly, taxpayers who have income not subject to withholding, taxpayers who may be self-employed, they also can make Estimated Payments. And the first estimated payment for 2007 is due on April 16, the same deadline for filing your Income Tax Return.

Knowledge: The dreaded work is, "Audit," for a lot of people. Are there some groups of people that are more open to being audited? Are we seeing an increase now? There was talk for awhile there, particularly after 911 that there was something of a decrease in the auditing team, but that didn't seem to be ramping up again, any thoughts on that?

Charles: Yes, the IRS has increased the number of audits of Individuals over the last couple of years. It had declined over time, over the last decade. But, Congress has given IRS more resources, and has directed them to increase their number of examinations. Last year, IRS examined 17,000 Individual Income Tax Returns that had income of over a million dollars, that's a significant percentage of those returns.

But, for general Individuals it's only about 1% of returns that are examined, that was 1.3 million last year. But, those that were picked to be examined, about 84%, there was some deficiency accessed, the remaining 16% had no change. But, the chance of being audited depends greatly on the characteristics of the return. Business returns have much higher audit rates than Individual returns.

Knowledge: It's one of those things you hear, and it's almost become this, you know accepted conventional wisdom, is that people who have, "home offices," are more open to being audited. But, again is it just looking at the numbers, more than having a home office?

Charles: There are many factors that determine whether an Individual Income Tax Return is audited. There's actually a formula, that Returns are scored based on the prior experience of IRS in auditing returns. And the more complicated Return, the higher income Return.

You know, the Return that has Self-Employment Income, those are more likely to be audited. But, it's pretty difficult to pick just one item, like a home office deduction, and suggest that might trigger an audit. It is just one of the many items that might influence the audit rate.

Knowledge: As you mentioned we're seeing more enforcement. How about in terms of criminal penalties? Have those changed? Have they gotten tougher over the last few years?

Charles: I don't know if the penalties themselves have gotten tougher. But, IRS does have more resources for criminal investigations now. Last year in 2006, they initiated about 3, 900 new criminal investigation cases. They also last year obtained 2,000 convictions for criminal violations, and of those 2,000 that were convicted, 82% of those were incarcerated. So, they really are going after serious criminal tax fraud.

Knowledge: How about 2007?

Charles: I think they are. When Congress allocated more resources for enforcement, they also increased resources for taxpayer assistance. And IRS on their 800 numbers, and also in their walk-up where you can visit their office, [where they] have Taxpayer Assistance Centers, and they really are a great help to the Individual taxpayers.

Finance Faculty