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With complex return, don’t put your life in software’s hands

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in Small Business Tax

Have you joined the millions of taxpayers who use computer software to complete their tax returns? For do-it-yourselfers, it's usually faster and easier than plowing through the paper version, and at a relatively low cost.

Strategy: Don't accept your software-completed return as the gospel. Check all entries carefully to ensure that the return is 100 percent accurate. And if your return is rather complex, it's still best to go with a trusted human tax adviser who will spot tax-saving opportunities that a computer can't.

IRS may give a second chance

Recently, the IRS allowed a taxpayer to amend his return because of an error in the tax-preparation software he used, according to an IRS private letter ruling reported by tax publisher CCH. (IRS LR 161402-04 unpublished, 3/22/05) But you may not be so lucky for goofs made on your return.

In the case, the taxpayer had relied for years on a tax adviser to complete his return. But when the adviser died, the taxpayer decided to use a nationally sold software program to compile his return. The return was fairly complicated, including income and deductions for a business and rental properties, as well as significant capital gains from stock transactions.

The taxpayer had bought some securities on margin, so the return reflected a sizable investment interest deduction. But the software failed to indicate that he could elect to treat part of the capital gain as investment income, and thereby deduct a larger amount of his investment interest expense from the margin borrowing (see box at right).

Two years later, the taxpayer sought professional tax assistance and was alerted to this mistake. But it was too late. The election could only be made within six months of the return's due date.

The good news: The taxpayer appealed to the IRS and, since the agency determined that he had acted reasonably and in good faith, it granted him a fresh 60 days to amend his return for the tax year in question.

By claiming the additional deduction, the taxpayer saved an astounding $73,000!

A further review of the software by tax experts revealed another error relating to the alternative minimum tax. The mistake caused taxpayers to pay tax on a state income tax refund when it wasn't required.

Bottom line: If your return is complicated, it's usually well worth the extra dollars to hire a tax professional to run the numbers. If you still want to use tax-prep software, consider paying your tax pro to do a pre-file check to spot any mistakes or overlooked opportunities.

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