Tax Return Preparation Services

Industry Snapshot

Tax return preparation services primarily operate during the first four months of the calendar year, since April 15 is the standard due date for federal tax return filings. According to Dun & Bradstreet, there were 38,287 tax preparation services operating in the United States in 2010. A majority of establishments were small: About 37 percent consisted of only one employee, and another 53 percent employed fewer than 10 people. Together these firms employed 128,393 people and generated $7.7 billion in annual revenues.

The main customers for such tax return experts as H&R Block and Jackson Hewitt are those who do not want to undertake the task themselves but are filing fairly simple returns. Taxpayers with complex tax issues usually turn to professionals. Although some tax preparers charge as little as $100, most charge at least $250, with charges for complicated returns reaching much higher.

In 2009, about 144 million individuals and 2.4 million corporations filed income tax returns, according to the IRS. About 76 percent of tax returns were filed electronically.

Organization and Structure

A number of Internal Revenue Service (IRS) regulations govern the preparation of tax returns that must be followed by members of this industry. All tax preparers are required to sign their clients' returns and provide additional identifying information, including the names of all persons assisting sufficiently in return preparation to qualify as preparers themselves. Because the IRS might contest only a portion of a complex return, it requires exact identification of the preparers responsible for each portion. In addition to furnishing clients with copies of their returns, preparers are required to keep copies on file for subsequent inspection. They are not, however, allowed to disclose personal information kept on file to other parties.

Preparers are penalized for negotiating the amount of a refund on a return or for accepting a refund as payment. This regulation arose because of unscrupulous preparers who had accepted refund checks as their preparation fees and then, without the clients' knowledge, increased the amount of the refund and pocketed the extra income. This form of abuse cheated customers and put these tax payers at risk of IRS penalty.

Any falsification of the tax amount owed or to be refunded is unacceptable, although tax return preparation services are not expected to make independent verification of the truth of a client's claims. Preparers are, however, expected to raise questions about uncertainties or apparent irregularities and cannot ignore a suspected mistake or falsehood.

False reporting and knowingly understating a client's true tax liability can result in penalties by the IRS. The government, however, assumes innocence in the case of certain errors, such as clerical or mathematical mistakes. The incorrect handling of elements of tax law does not incur penalty if the IRS judges those elements sufficiently technical or uncommon as to excuse the preparer.

Background and Development

Temporarily necessitated by the Civil War, federal income tax did not become a permanent fixture in the United States until February 1913, when it was ratified as the Sixteenth Amendment to the Constitution. Subsequent revenue acts were codified in 1939 and again in 1954 as the Internal Revenue Code, which was recodified in 1986 after passage of the 1986 Tax Reform Act.

The 1913 income tax produced a degree of chaos because of the haste with which it was introduced and the lack of guidance offered to those preparing returns. As late as 1939, less than 6 percent of the population was affected by federal tax. By the end of World War II, more than three-quarters of the population were subject to federal tax. This major increase in scope set the stage for tax return preparation services to assume a heightened importance and presence. In a fairly short period of time, a service industry of rapidly growing dimension took shape.

Traditionally, tax returns have been filed through U.S. postal mail. Indeed, for years, as midnight drew near on April 15, post offices were congested with long lines of last-minute filers rushing to mail their returns before the tax deadline. A paper tax return received by the IRS through the mail is processed through what the IRS calls "pipeline processing." Once received, the return must go through sorting, batching, numbering, coding, data entry, error resolution, and storage. The entire process can take between six to eight weeks to complete. Not until this process was completed could a return be processed for refund. During peak filing periods, refunds could take as long as eight weeks to be returned to the taxpayer. While some paper filing still occurred in the early 2010s, a large majority of tax returns were filed electronically.

Championed by the IRS, the trend toward electronic filing grew quickly. Electronic filing reduces the amount of time it takes for a taxpayer to receive a federal tax refund and provides a greater guarantee to the taxpayer that the return is mathematically correct. An electronically filed return also eliminates the initial steps of pipeline processing. Electronic filing uses automation to replace most of the manual steps needed to process paper returns, resulting in faster and more accurate processing. In the late 2000s tax preparers who were registered with the IRS as electronic filing originators (EFOs) could file returns electronically to the IRS for a fee. Using this method, a refund took about three weeks to be returned; refunds could be received sooner if a taxpayer chose to have the refund deposited directly into a savings or checking account.

In the mid- to late 2000s tax preparation software and Web-based filing became extremely popular with people who filed simple returns and did not employ a tax preparation specialist. Brian L. Clark noted in Money, "For taxpayers who prepare their own returns, the biggest decision used to be which software program to buy. These days, it's whether you should use a program at all or just go to one of the programs' Web site." Tax preparation software for individuals cost between $20 and $40, while online filing fees ran about $20 for federal and $10 for state returns. According to TurboTax, the average Turbo Tax software user was between the ages of 35 and 54, college educated, with an income between $50,000 to $75,000. Two-thirds of Turbo Tax's customers were men, and most had previously used a tax software program. Those most likely to file using Turbo Tax's Web-based program were between the ages of 18 and 45, college educated, with an income level between $25,000 and $50,000. Due to the growing popularity of such tax software programs, about 16.6 million Americans prepared their own taxes in 2005, up 17.3 percent from the previous year.

An eligible electronic filing customer could also apply for a refund anticipation loan (RAL). Within one week after the date of filing--and sometimes on the day of filing--the filer received a check in the amount of the loan, less the bank's transaction fee and any tax return preparation fee. The IRS then directly deposited the filer's actual federal income tax refund into a designated account at the bank in order for the loan to be repaid. The bank charged interest on the loan.

According to the Consumer Federation of American and the National Consumer Law Center, about 7.2 million Americans received tax refund anticipation loans (RALs) for tax year 2008. These loans, which are based on the amount of an anticipated tax return, began to come under scrutiny by consumer advocacy groups because of the high fees they carried. The loans cost, on average, between $35 to $90 but could reach as high as $250. In 2003, Massachusetts became the first state to place a cap on prices for these loans.

Current Conditions

Tax experts who used RALs to bring in customers hit a glitch in 2010, when the IRS announced it would no longer release the information needed for efficient processing of RALs. In the past, the IRS could instantly let the tax preparer know whether the individual filing the return was entitled to the full return or whether he or she owed money in such things as back taxes or unpaid child support. Without instantaneous access to this data, tax preparers could not hand the individuals their refund check (minus the tax preparer's fee) before they walked out the door. As a result, many of the small firms that depended on RAL fees to survive went out of business. Others, such as H&R Block, lost a significant source of revenue. According to the Personal Finance Bulletin, H&R Block earned $146 million from RAL and RAC (refund anticipation checks) programs in 2010. About 45 percent of the firm's customers, many of whom were low-income, took advantage of RALs.

Other changes that were expected to affect tax return preparation services included a new requirement, beginning in 2011, by the IRS that all tax return preparers who are not certified public accountants or attornies pass a competency test to obtain a practitioner tax identification number (PTIN) and officially become a registered tax return preparer. These tax preparers would also be required to take 15 hours of continuing education in order to maintain their position as an official tax preparer. In addition, many states were beginning to require electronic filing, and, beginning in 2012, any tax return preparer that filed more than 10 returns was required to become an Electronic Return Originator, or e-file provider, based on federal law.

Industry Leaders

With sales of more than $3.8 billion in 2009, H&R Block Inc. of Kansas City, Missouri, easily outpaced its nearest competitors. In 2010, H&R Block served about 23 million taxpayers in the United States, Canada, and Australia. H&R Block had approximately 11,500 retail locations throughout the United States, of which about 35 percent are franchised operations, and another 1,600 in Canada and Australia. H&R Block was also one of the largest seasonal white-collar employers in the United States, with a total payroll of 110,400. In order to maintain its workforce, H&R Block offered good pay, stock options, and commissions. In the late 1990s, H&R Block started to expand from its traditional operation, offering investment, tax planning, and mortgage services. By the late 2000s it was also offering its own do-it-yourself tax preparation software.

The second largest tax return preparer in the United States in 2010 was Jackson Hewitt Tax Service Inc. of Parsippany, New Jersey. Jackson Hewitt served mostly low- and middle-income customers through about 6,300 offices, most of which were franchises. Some of the offices were located in malls and Wal-Mart stores. The company was expanding in the early 2010s, and at that time served about 2 million customers. Approximately 95 percent of the firm's $213 million in annual revenues came from services rendered during January through April.

JTH Tax Inc. of Virginia Beach, Virginia, held the number-three spot in tax return preparation services in the United States in 2010, with $82 million in annual sales. The firm conducted business under the Liberty Tax Service banner and operated about 3,500 offices throughout the United States, about 2,000 of which were franchises.

The main competitor for on-site tax return preparation services was software company Intiut, Inc., based in Mountain View, California. Intuit sold personal finance (Quicken), small business accounting (QuickBooks), and consumer tax-preparation software (TurboTax). According to the company, 50 million Americans used its products in 2010. With 7,700 employees, the company posted revenues of more than $3.4 billion in 2009.