DIY Tax Preparation: 5 Things You Need To Know

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Every business owner is required to complete a tax return every year, whether or not the business makes any money. The majority opt to use tax professionals for the task. However, a number of business owners decide to do it themselves, often because this can be a less costly route (especially when the business is very small).

If you do choose to prepare your own tax returns, tax preparation software can be a big help. You don't have need an accounting background to use the software, but you should understand some software decisions you'll need to make and how to use the software effectively.

Where's the best place to start? Here are five things you need to know.

1. You need separate software for personal and business taxes.
If you run a business, you may need more than one software package to complete your taxes for the year. You'll need separate software, such as TurboTax Business, if you're required to submit a Form 1065 (for a partnership or limited liability company with two or more owners), Form 1120S (for an S corporation) or Form 1120 (for a C corporation). In addition, you'll need another software package to prepare your personal return, Form 1040, and report income and other taxable distributions from your business.

If your business is a sole proprietorship or a limited liability company with one owner, you need only one application that can prepare a Schedule C as part of your Form 1040. Be sure to select software specifically designed for Schedule C filers, such as TurboTax Home and Business or H&R Block at Home Premium for the Self-Employed.

2. Software alone won't save you money.
What you do throughout the year will affect the taxes you have to pay. The software doesn't create tax savings out of thin air. It's up to you to keep great records of your income and expenses so the software can optimize your tax savings.

For example, the software can show you alternative tax treatments for certain items and you can select the one producing the greater tax savings. Say you use your personal car for business. The software will need all of your driving information; it will then show you the deduction produced if you opt for the IRS-set standard mileage rate or your actual driving expenses.

3. Consider the variety of tax preparation options.
Some individuals with adjusted gross income below set limits have access to "Free File," which is an online way to complete and e-file federal income tax returns. This option may not be suitable for business owners who need to attach Schedule C or other business forms, because not all Free File providers offer these forms or they impose income limits that owners may exceed. (You can find Free File providers at www.irs.gov by entering "Free File" in the search box).

There are two ways to use your computer to prepare a business tax return:

  • Install software on your computer.
  • Use an Internet-based solution where you log on to work on your return and store your data.

The cost for both options is about the same. The advantage to the online version is the fact that your data is stored remotely by the software company.

4. Software can cut down on errors and make filing easier.
Instead of preparing a paper return by hand, using software can greatly reduce mathematical and other errors that can delay processing of the return and even result in penalties and interest. It has been noted by the IRS that computer-generated returns have a less than 1 percent error rate, compared with more than 20 percent on paper returns.

Computer-prepared returns can easily be filed electronically (e-filed) with the IRS (and your state). A simple keystroke can send your return in before the deadline and avoid the need to stand in line at the post office at the last minute. If you e-file, you'll receive an e-mail acknowledging that your return has been accepted for filing.

Here's a tip: Because an incomplete or inaccurate return that is e-filed may be rejected, it's wise to e-file a couple of days before the deadline so errors can be corrected and the return re-submitted.

5. You can't avoid penalties merely because you use software.
If you ultimately submit a computer-prepared return that has a substantial underpayment, you could owe a 20 percent accuracy-related penalty, along with taxes and interest. The penalty can be avoided by showing that you acted in good faith and had reasonable cause for making an error. The mere fact that you used software to prepare your return is not reasonable cause to avoid this penalty. According to the Tax Court, "Tax preparation software is only as good as the information one inputs into it." The courts have rejected the so-called "Geithner defense" (based on statements made by Treasury Secretary Timothy Geithner during his confirmation hearing), which says that no accuracy-related penalties should be imposed if a taxpayer uses tax preparation software.

The original version of this article appeared on AOL Small Business on 3/28/11.

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