Taxation principles and policy frameworks

¶ … Tax Professionals, Tax Refunds, and Fees

Hatfield, Jackson and Schafer (2008) investigate the relationships between tax professionals, tax refunds and fees. Several relationships were discovered. First, tax professionals may advise clients to make larger than necessary quarterly tax payments, in order to generate a tax refund, as a means of increasing the favorable perception of their services. In addition, the amount the tax professional charges for their preparation services is often affected by the amount of refund the tax professional can engineer.

Relation Between Tax Professionals, Tax Refunds and Fees

Hatfield, Jackson and Schafer (2008) investigate the relationships between tax professionals, tax refunds and fees. Their study examined if tax professionals contributed to the high incidence of tax refunds, in the United States, despite the fact that taxpayers are often advised not to overpay their taxes. The study begins by noting that 132 million people filed a tax return, in 2004, in the United States. Of those, nearly 78% resulted in a tax refund, averaging more than $2,400. These over payments are not a new phenomena, but instead of occurred since the 1940s. The authors investigate three relationships, including: tax professionals' advice regarding the amount of quarterly estimated tax payments, taxpayers' tax refund and their tax due position, and the amount of tax preparation fees billed to taxpayers, in an effort to identify "an underlying cause of tax refunds and a wealth-related consequence that tax refunds may engender" (p. 20).

Previous research on the subject showed several reasons taxpayers may overpay their taxes. These include a desire to accumulate savings. Research showed that some taxpayers overpay in an effort to avoid the negative feelings associated with owing taxes. Past research had shown that consumers felt that payments were more painful than the perceived benefits. Some taxpayers dislike the uncertainty of owing taxes and enjoy receiving a refund check. One study showed that taxpayers wanted to avoid the transaction costs of adjusting their withholding position. However, Hatfield, Jackson and Schafer (2008) surmise that research had not been completed regarding how tax professionals' advice affected overpayment.

The researchers found that there were two primary reasons tax professionals advised their clients to make larger quarterly estimated tax payments. First, they often offered this advice if the client was likely to positively associate the benefits of having their tax returns professionally prepared with receiving a refund. Second, tax professionals were more likely to recommend larger quarterly estimated tax payments if they felt the taxpayer was more willing to pay a higher preparation fee, if they received a refund. By engineering tax refunds, tax professionals sometimes use this to psychologically offset the preparation fees charged by the professional. Research in psychology theorizes that taxpayers who owe taxes, or who receive a refund for an amount less than their preparation fees, are likely to mentally categorize the preparation experience as a net loss, despite the benefits of a tax due strategy. In contrast, those who receive a refund larger than the preparation fees mentally judge the experience as a net gain (Hatfield, Jackson & Schafer, 2008).

The consequences of tax refunds, for tax payers, include larger fractions of billable fees being billed to the client, then when they owe additional taxes. This is true even with the tax liability itself is constant. This finding goes beyond the commonly understood consequence of overpaying taxes -- a loss of investment income, by giving the government an interest-free loan. An additional wealth-related consequence is the higher preparation fees those receiving refunds pay. This affects millions of taxpayers as approximately 25% of taxpayers made tax payments via quarterly estimated tax payments (Hatfield, Jackson & Schafer, 2008). There are several ethical implications to these relationships as well.

Hatfield, Jackson and Schafer (2008) note the recent investigation into Jackson Hewitt franchises and the generation of fraudulent refunds. These types of firms often also earn additional income from refund anticipation loans. This behavior is contrary to tax professionals standards of conduct, established by both the IRS and the American Institute of Certified Public Accountants (AICPA). AICPA Rule 302 expressly prohibits contingent fee arrangements, for preparing original tax returns. For this reason, not only are these findings of interest to taxpayers, but also to agencies charged with regulating tax professionals.

The researchers conclude that using whether or not a taxpayer receives a refund or has to pay taxes, is not a proper decision-making heuristic. Receiving a refund is not an effective means of gauging a tax professional's performance. Tax professionals understand that clients may judge their performance on whether or not they receive a refund. This enhanced perception acts as an incentive to motivate tax professionals to engineer tax refunds, through advising clients to make larger quarterly payments (Hatfield, Jackson & Schafer, 2008).