A taxpayer should hire an accountant when doing so will save more money than the accountant costs. Accountants are usually worth the price when someone’s tax bill clears a certain threshold, or when a tax situation is sufficiently complex.
We explain below why people shouldn’t do their own taxes. We also show how to figure out the cost of an accountant and how to estimate how much an accountant will save you on your tax bill
Why Shouldn’t People do Their Own Taxes?
The IRS reports that the error rate for paper tax returns is a sky-high 21%. Compare that to .05% for returns prepared with tax prep software. The automation in the software weeds out mistakes the same way guards on lawnmowers prevent the loss of toes and fingers. It’s not that people can’t avoid cutting off extremities if they pay attention. It’s more that everybody loses concentration sometimes. Further, tax mistakes cost money. They cut down the size of the return or make it too big, incurring fines and interest. Using tax prep software helps avoid mistakes and ultimately saves money.
Beyond that, according to Jeff Prior, C.P.A., “A lot of people who do their own taxes miss out on certain deductions and credits because they’re unaware that they exist. That’s why H&R Block reviews people’s taxes for free. They usually find something that was missed.”
When Tax Software is Not Enough
There are several reasons to take the step beyond tax software and hire an accountant. A good rule of thumb is: If an accountant can save a taxpayer more money than they cost, they’re worth the price. That usually means a bigger refund or a smaller tax bill than the consumer would get on their own.
Step #1: Learn How Much an Accountant Costs
To figure out if an accountant will save you more money than they cost, you have to know two things: 1. How much they’ll save you and 2. how much they cost. We’ll start with #2.
The National Society of Accountants estimated that in 2013, the average cost of tax preparation by a professional was $261.
However, prices vary depending on the city, state and individual accountant. This is the same as how doctors cost more or less depending on their location, reputation, and expertise.
For a benchmark, H&R Block, one of the largest tax prep firms in the U.S., charges around $160 to prepare both federal and state tax returns in New York City. However, a top-flight accountant with his own private practice might charge anywhere from $400 all the way up to $1,500 to prepare a tax return.
When pricing out accountants, do a little comparison shopping. Ask around and look online. Find an accountant with a good reputation. Decide whether one of the big services, like H&R Block or Jackson Hewitt, would be a good fit, or whether you’d rather hire an individual.
Step #2: Decide if the Accountant Will Save More Than the Cost
Once you have a good idea how much an accountant costs, determine how much money they might save you. A good starting point is last year’s tax return.
Someone with an income of $15,000 probably doesn’t need to hire an accountant. After standard deductions and exemptions, their maximum tax bill will only be around $500. Chances are good that someone at this income level will get their biggest refund using tax prep software.
When income levels start to rise however, there’s more potential to find additional deductions that could help save money. An accountant might find savings for someone with an income in the $50,000 range. This gets especially significant as someone’s income rises above the $52,800 level that can push them into owing the complex Alternative Minimum Tax.
Complexity of the Financial Situation
Next, look at the complexity of the financial situation. Tax software does a great job handling simple and even moderately complex situations. Is there a 1040 to fill out, one W-2, a 1099, and not a lot else? Then tax software will likely do the job and get the biggest refund allowable by law.
But as the situation gains complexity, tax software might miss out on some savings. K1s, small business concerns, foreign income and real estate bought and sold are all items that can complicate a taxpayer’s financial profile. When these factors enter the picture, an accountant might be able to see and do things simple software might pass over.
Some Examples of Complex Situations:
- Small Businesses. Many small businesses can use tax preparation software with no ill effects. But as a business grows and gets more complicated, a human tax preparer is a good idea. Multiple employees, losses, long lists of deductions, and rental properties are all signals that professional help is needed.
- Over $200,000 in Income. The audit risk for those claiming over $200,000 in income is more than twice that of the general population. As people cross this threshold, there’s more value in having a trained professional in their corner.
- Less Common Tax Forms. A taxpayer who receives K1 forms, has foreign source income, or uses other less-than-common forms can benefit from the help of a professional. Again, an accountant might see opportunities for tax savings in these forms that software can miss.
- Alternative Minimum Tax. The AMT can raise a tax bill by disallowing several common deductions. These include the standard deduction, personal exemptions and exemptions for property tax. The AMT is also difficult to figure out, with a 12-line worksheet, 8 pages of instructions and a 55-line form. This complexity is probably why The President’s Advisory Panel on Federal Tax Reform found that 75% of people who pay the AMT hire a professional. Individuals with incomes above $52,800 are liable for the AMT.
- Providing for Your Children’s Future. Accountants can help set up trusts for inheritances or 529 plans for college savings. They can also help with decisions about how to save money tax-free in IRAs and 401Ks. This kind of advice can save their clients money on their tax bills. It can also save them large amounts of money down the road.
- Selling Real Estate or Realizing a Large Capital Gain. Selling a real estate investment doesn’t have to mean a large tax bill if the plan is to buy another, similar investment with the proceeds. This transaction, called a like-kind exchange, can be tricky to set up without the help of a professional. Capital gains, like sales of property and stocks, can also be complex. An accountant can cut through the regulation tangle to arrive at the smallest possible tax liability.
When preparing taxes, it’s a good idea to use at least the help of a good tax software package, like TurboTax, H&R Block, or TaxACT. As personal income grows and a financial situation gains complexity, an accountant’s services can be worth the expense. In other words, if the cost of hiring an accountant won’t exceed the resulting tax savings, then choosing an accountant is never a bad move.
- Tax Return Preparation Fee Averages $261 – National Society of Accountants
- Simple, Fair and Pro-Growth: Proposals to Fix America’s Tax System – Tax Policy Center