Tax Return Preparation Services

SIC 7291
TAX RETURN PREPARATION SERVICES

This category covers establishments that primarily provide tax return preparation services without also providing accounting, auditing, or bookkeeping services. Establishments engaged in providing income tax return preparation services that also provide accounting, auditing, or bookkeeping services are classified in SIC 8721: Accounting, Auditing, and Bookkeeping Services.

NAICS Code(s)

541213 (Tax 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 a survey conducted by Tiburon Strategic Advisors, along with several other research and survey groups, in 2002 there were 450,000 certified public accountants (CPAs) in the United States, as well as 40,000 enrolled agents (EAs). Of these, nearly all EAs and 170,000 CPAs were in private practice, with tax planning and tax return preparation as the primary revenue source.

Organization and Structure

According to Tax Return Preparer's Liability, 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, as midnight draws near on April 15, post offices are 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 "pipe-line 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 is completed can a return be processed for refund. During peak filing periods, refunds can take as long as eight weeks to be returned to the taxpayer. While paper filing is still common today, the age of computers has introduced electronic filing of tax returns.

Championed by the IRS, the trend toward electronic filing is growing. 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 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. Tax preparers who are registered with the IRS as Electronic Filing Originators (EFOs) can file returns electronically to the IRS for a fee—typically $15 to $25. Using this method, a refund takes about three weeks to be returned; refunds may be received sooner if a taxpayer chooses to have the refund deposited directly into a savings or checking account.

An eligible electronic filing customer may also apply for a refund anticipation loan (RAL). Within one week after the date of filing, the filer receives a check in the amount of the loan, less the bank's transaction fee and any tax return preparation fee. The IRS then directly deposits 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 charges interest on the loan.

Current Conditions

In 2002, about 47 million Americans filed the federal tax returns electronically, with that number growing to an estimated 54 million in 2003. In 2003 the IRS rolled out a new program called Free File that offered free online tax return filing for certain segments of the population. The IRS offered these free services through a partnership with 17 tax preparation companies.

Tax preparation software and Web-based filing have become extremely popular with people who file simple returns and do 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 costs between $20 and $40. Online filing fees run about $20 for federal and $10 for state returns. According to TurboTax's Web site, the average Turbo Tax software user is 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 are men, and most have previously used a tax software program. Those most likely to file using Turbo Tax's Web-based program are between the ages of 18 and 45, college educated, with an income level between $25,000 and $50,000.

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 involved 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.

According to the Consumer Federation of America and the Consumer Law Center, consumers paid almost $2 billion in fees and charges related to tax refund anticipation loans. These loans, which are based on the amount of an anticipated tax return, have come under scrutiny by consumer advocacy groups because of the high fees they carry. The loans cost, on average, between $35 to $90 but can reach as high as $250. In 2003 Massachusetts became the first state to place a cap on prices for these loans. However, the Massachusetts law is not expected to significantly affect the tax return loan industry unless other states follow suit.

Industry Leaders

With sales of more than $2.9 billion in 2002, resulting in a net profit of $434.4 million, H&R Block easily outpaced its nearest competitors. In 2002, H&R Block served about 19 million taxpayers in the United States, Canada, and Australia. H&R Block has approximately 10,000 offices located throughout the United States, of which about 4,500 are franchised operations. H&R Block is the largest seasonal white-collar employer in the United States. It has approximately 1,200 regular full-time employees and hires nearly 100,000 seasonal employees. In order to maintain its workforce, H&R Block offers good pay, stock options, and commissions that range from 20 to 30 percent. In the late 1990s H&R Block started to expand from its traditional operation, offering investment, tax planning and mortgage services. It also bought eight accounting firms to start its own U.S. accounting firm.

Software company Intuit sells personal finance (Quicken), small business accounting (QuickBooks), and consumer tax-preparation software (TurboTax). Intuit posted revenues of $1.4 billion in 2002, resulting in a net income of $140.2. Intuit also provides on-line filing options at turbotax.com.