Tangled Web of U.S. Tax Preparation
For a number of years, Money Magazine would hold a contest between fifty tax preparers representing every state in the union. The publisher would provide each preparer with the same tax data in the role of a fictitious client. In most years, the results of each return were different – no two were identical.
In spite of the fact that each tax return was prepared using tax software, the differences in each return was because the judgment and training of no preparer was the same. Concepts of accounting can vary even among those who have studied the subject. What constitutes cash income and what expenses are deductible. Is income recognized in the year incurred or invoiced? Are expenses 100% deductible or must some formula be applied based on usage? Does the taxpayer materially participate in the activity? How are passive activity losses applied? When is a business declared a hobby and the deductions consequently denied? What are the qualifications for taking the foreign earned income exclusion? What happens when the exclusion amount is exceeded? What about medical costs related to a nursing home or elderly parent?
As there are over 1,700 pages in the Internal Revenue Code and perhaps three times this number in the Regulations, the challenges of tax preparation can be daunting. The best a tax preparer can do is prepare a tax return based on verifiable evidence provided by the client so that in the event of audit the return is defensible.
Not infrequently will an American expatriate prepare his or her own tax return. Tax software such as Turbo-tax costs around $20 to $35 and can be purchased on-line, or at www.amazon.com. It takes the novice step by step through the preparation process. Software or even manual preparation requiring little skill owing to a fewness of income flows is manageable. But throw in a few questions like those listed above and tax preparation can quickly turn unmanageable.