First, I need to get this out of the way: I don’t consider using tax software to be “doing your own taxes.” I hear that kind of language all the time, but I disagree with it. When you use tax software, you are not using your brain and you don’t gain any understanding of how income taxes are calculated or why.
I have observed that very few people I know prepare their own tax returns, despite my positioning in a demographic in which tax returns are likely as simple as they’re ever going to be in our lifetimes. Most people I know try to use tax software or send their information off to their parents’ accountant. A few will avail themselves of local free help. But almost none actually look at a 1040, read the instructions when necessary, and attempt to fill it out.
I have a big bias here that will come out through this post because of how I’ve been paid. As a grad student, if you’re on the compensatory payroll system, everything is good – you get a W-2 like a normal person that everyone knows how to deal with. But if you are on the non-compensatory payroll system and receive 1099-MISC box 3 income (or worse, just a courtesy letter), suddenly the professionals (tax software and tax preparers) get confused and usually try to convince you that you are self-employed. Once you look into it, you realize that it’s not any more difficult to prepare a return with 1099-MISC box 3 income than it is with W-2 income, it’s just that it’s an unusual situation so it throws people who are used to seeing only W-2 or 1099-MISC box 7 income for a loop.
Here are my three basic points for this post:
1) Understanding the foundational principles of the tax code is part of being a responsible citizen.
2) People with uncomplicated financial lives (most young people) are capable of preparing their own tax returns.
3) Grad students receiving fellowship income should prepare their own returns (at minimum, understand the quirks of their situation) because it’s unlikely that a tax preparer or software will do it properly without aggressive intervention.
Start Out Young
When I was in college, my parents took care of my tax return as well. But as soon as I started working full-time, I began to build my knowledge of how to prepare my own tax return. Going off the principle that no one cares more about my money than I do, I realized that if I wanted to be confident that my tax returns were prepared properly, I would have to practice doing them myself (at times, in conjunction with free software).
If you’re going to understand the tax code at a layperson level, there is no better time to start than when you’re young and uncomplicated. This is the path that Kyle and I have followed and it’s been a steady learning curve.
- At first, our income was all W-2, 1099-MISC, and interest from bank accounts. We took (and still take) the standard deduction and don’t own a home.
- A few years later, we learned how to deal with dividend income from our taxable investments.
- In 2013, we had our first bit of self-employment income and we learned about the schedule C and self-employment taxes. Our situation is still simple because we aren’t taking aggressive deductions related to our business.
- When we sell our taxable investments to pay off my student loans (likely in 2014), we’ll learn more about capital gains taxes.
Eventually, I’m sure our tax situation will become complicated enough that we will pay someone or some software to prepare our tax returns for us, both for their expertise and for their time. I expect that time will come when we own a home, no longer take the standard deduction, or get more involved with self-employment deductions. But because we took the time to slowly learn about the tax code and prepare our own returns when they were easy and not too time-consuming, we have a basic understanding of how the code operates. Later on, we can be educated consumers instead of just blindly throwing numbers at a person or a program and hoping it comes out correctly in the end.
If your tax return is complicated from the time you graduate from college, I understand the reluctance to prepare your own returns and it probably is the best route to pay for someone to prepare them. But that doesn’t exempt you from needing to understand how the return is prepared, and you can take a few seasons to catch up to where, even if you couldn’t prepare the return yourself, you at least can look through the completed return to catch any errors.
If you only have a few sources of income and take the standard deduction, I am confident that you could prepare your own return and be better off for doing it! Just download a 1040 (or 1040-EZ if you can get away with it) and start filling out. If you run into a prompt you don’t understand, read the instructions for that line. It might take a couple hours but I think you’ll have a sense of satisfaction when you are finished. (And don’t kid yourself – using tax software to prepare your returns is also very time-consuming. You have to import all your forms and answer lots of irrelevant questions as the software prompts you for deductions you know you won’t end up taking.)
The Professionals Are Not Necessarily Competent
I have personally heard so many horror stories about tax returns being prepared incorrectly or bad tax advice coming from professionals from my grad student peers.
1) I have literally never heard of a professional tax preparer properly filling out a grad student’s return if it involved involved 1099-MISC box 3 income. (To be fair, most people I know don’t use people to prepare their returns, so it’s only a handful of examples.) And those are just the cases where the student caught the mistake. I’ve had another conversation with a peer wherein I had to inform him that his previous returns had been prepared incorrectly – for years.
2) Several of my labmates have gone to the volunteer tax preparers are our university for help with their NSF fellowship income and almost none has come back with the correct answer for how to deal with a courtesy letter or 1099-MISC box 3 income. And these are volunteers at the university – why couldn’t they have been briefed on the typical tax issues of the students?
3) While not impossible, it’s notoriously difficult and non-intuitive to get the free versions of tax software to accept 1099-MISC box 3 income. If a student doesn’t know better, she can easily be misled into telling the software that she is self-employed.
Ultimately, You Are Responsible
At the end of the day, each of us is responsible for our own tax returns, no matter how they are prepared. Again, I don’t think you should have to become a tax expert if that’s what your return requires. But I believe you should have a general idea of what’s going on (e.g. the difference between a credit and deduction) and be able to look at a completed return and confirm that it accurately reflects the financial story of your year. I believe the best way to accomplish that is to prepare your own returns for a few years – and sure, check it against the software if you like to catch your mistakes!
Come back on Wednesday to see my guide to entering fellowship income into TurboTax! I wrestled with it for hours this past weekend just for you! 😉
By what method do most people you know prepare their taxes? Have you ever done your taxes yourself (by hand)? How competent is your understanding of how income taxes are calculated?
photo from Free Digital Photos