Will your key open the door that leads to success?
By James A. Woehlke
The tax practices of most CPA firms are undergoing a tremendous period of change. Tax practices today include three components, compliance, planning, and representation. Factors that will impact these aspects of practice include information technology, the domestic legislative environment, and the economics of practice.
Three information technology factors having the most obvious impact on tax practice are technological substitution, disintermediation, and convergence. These factors are converting tax compliance into a clerical function.
Our current tax system has become very inefficient and overly intrusive. As a result, there are proposals for either a flat tax or a national sales tax. Under either proposal, tax compliance would be seriously impacted.
There are two economic issues impacting tax practices. First, competition for tax clients is much more pronounced than a generation ago. Second, the loosening up of restrictions on nontraditional billing arrangements opens the door for new services.
While tax planning and representation will continue to be strong in the future, compliance work will continue to decline. To offset this loss, CPAs must be nimble and offer services that tap into skills they already possess.
Most CPA firms' tax practices make up from 40% to 80% of their revenues. When CPAs introduce themselves to people at social gatherings, the first things out of the social companions' mouths are questions about taxes. To many people, the CPA is Mr. or Ms. Tax. All CPAs seem to enjoy this stereotype, even those who voraciously devour FASB opinions and don't even prepare their own returns!
Taxes have been so closely tied to the CPA's identity because tax systems rely so heavily on accounting information to determine the amount of tax. Unlike other non-legal professions, CPAs are recognized in Federal law as having the right to practice tax law, at least outside the court system.
Currently both the CPA profession and the environment in which it practices are in a tremendous period of change. How will CPAs in tax practice weather these changes over the next generation? Will CPAs in the next generation still be seen as Mr. and Ms. Tax? The future of tax practice is bright, but not necessarily the same tax practice CPAs know today.
What Is Tax Practice Today?
Nearly all tax practices are a blend of three component practice areas: compliance, planning, and representation. In spite of the heavy inroads made by H&R Block and TurboTax, most practices today still have a heavy concentration in compliance areas.
Tax compliance is the collection of relevant tax data and the rearranging of the data in a format approved by the government for the filing of tax returns. It includes advising the client about what records must be kept to support a tax return position. Tax compliance, more than planning and representation, is governed by the clock. The value perceived by the client is lower. Clients believe the CPA is saving them time and frustration in avoiding an IRS audit. The most important aspect of tax compliance from a practice management perspective is its use as a springboard into more highly valued services.
With tax planning the client saves money. The client perceives a higher value, and therefore the CPA has the opportunity, frequently overlooked, to price the planning services higher and achieve a greater realization. Tax planning is a consulting service, one of the oldest offered by CPAs, and is at the heart of other CPA services such as personal financial planning. The most sophisticated tax planners climb out of the tax expert mode and also advise the client as to whether the lifestyle or transactional adjustments necessitated by the planning advice make sense from a broader perspective.
Tax Representation. Many clients have raw fear of facing the dreaded IRS auditor. Recent hearings into the arbitrariness of some IRS collections people have magnified this angst. So, tax representation may have even higher perceived value than tax planning. Not only is client wealth preserved by expert tax representation, but perhaps also the client's freedom. The essence of tax representation is knowing how the IRS works in the examinations and collections areas. What do 30- and 90-day letters mean? What kind and amount of information will it take to satisfy an auditor? How much will the IRS compromise a tax or penalty liability? When and how can tax liens be removed? Negotiation skills are critical. How far can the IRS be pushed? How hard can it push back?
Factors Influencing Tax Practice
What environmental factors are evident today that will impact tax practice tomorrow? Global factorsthe internationalization of the economy in general and the capital markets in particular, the worldwide spread of democracywill certainly impact CPA practice over a longer term; but in the near term, information technology, the domestic legislative environment, and the economics of practice pose the risks of most rapid change to tax practice.
Information Technology (Infotech)
The three infotech factors having the most obvious impact on tax practice are technological substitution, disintermediation, and convergence.
Technological substitution is a new-fangled word for automation. Throughout the industrial age, automation was responsible for changing and improving the economy's ability to serve more people with better products and services at ever-cheaper cost. Automation caused a great deal of dislocation, but historically resulted in increased employment and higher-level jobs. It allowed people to move from jobs filled with drudgery to more interesting, often better paying positions. The automation trend is continuing into the "information age" with enormous impact on service businesses.
Former AICPA Special Committee on Assurance Services Chairperson Robert Elliott noted that while audit revenues have remained relatively flat in recent years, audit staff declined 20%. In tax practice technological substitution enabled CPAs to move away from hand-preparation and batch processing of returns, in both instances eliminating clerical steps in the return preparation process. Many firms now combine the client interview with data input, enabling tax practitioners to take over jobs previously performed by clerical personnel. To maintain appropriate leverage, some of these firms have also permitted the client interview to be performed by managers and lower-level staff, reserving for partners interviews with the most important clients.
Another example of technology substitution that hits tax practice directly is the use of alternative filing methods by the IRS. In the 1997 filing season, the IRS mailed out invitations to 23 million people to file their Form 1040EZ information using TeleFile (filing by telephone), and 4.7 million taxpayers accepted the invitation. If the 1040EZ is handled so easily, can the Form 1040A be far behind? Will it progress to the 1040 itself? Beginning this year, the IRS is inviting taxpayers to electronically file, or e-file, their returns using their home PCs. For the present, e-filed returns must be sent through an IRS-approved "transmitter." But can direct taxpayer-to-IRS transmissions be far off? On March 6, 1998, the BNA Daily Tax Report reported, "[IRS Commissioner] Rossotti said, 'there is still too much paper involved,' pointing out that IRS is 'working very aggressively' to implement a paperless filing system by the 1999 filing season. He predicted 'it won't be too long' before a majority of U.S. taxpayers file their returns electronically."
Technological substitution is also responsible for the top-to-bottom change in the CPA profession's market structure. A generation ago, it was not possible for a senior staff person to break away from a larger firm and offer a similar level of service to that of her former employer. Then the PC entered the scene. A renegade staff person could now set up an office in a corner of his or her apartment and offer a complete line of CPA services without even the need for clerical support! Many new firms were born, and those firms have grown.
Disintermediation is the elimination of intermediate vendors, middlemen. Bill Gates, in his book The Road Ahead
Industry after industry will be changed [by the development of the information highway], and change is unsettling. Some middlemen who handle information or product distribution will find they no longer add value and change fields, whereas others will rise to the competitive challenge. There is a nearly infinite number of tasks left undone in services, education, and urban affairs, to say nothing of the workforce the highway itself will require. So this new efficiency will create all sorts of exciting employment opportunities....There will be dislocations. However, overall, society will benefit from these changes.
A friend tells the story of his demonstrating an Internet web site to an insurance broker. After a visitor to the web site inputs some personal information, the site checks the features and prices of hundreds of products from dozens of companies and almost instantly lists the lowest priced policies. The insurance agent's mouth dropped to the floor. He could see his livelihood was in jeopardy. This is exactly the sort of change Mr. Gates was predicting.
Tax practitioners need to identify where in their practices they are adding the least value, where they are primarily middlemen. They should recognize that infotech will sap the value out of these services, largely converting them into clerical services.
Convergence is the combination of more and more functions into fewer and fewer devices. Every day, people are faced by dozens of electronic screens, including watches, TVs, computers, telephones, pagers, and calculators. Already computers can be set up to perform all of these functions, while the "box" shrinks in size and weight. Banks like Citibank and Chase are permitting customers to perform all their banking, except depositing and withdrawing cash, with a computer. Yet in the very near future (it is already happening in Europe) computer users will be able to use smartcards to deposit and withdraw "cash" from their home and office PCs as well. It's not too hard to imagine a device, perhaps a wallet PC, that makes money transfers while automatically classifying the transaction for tax and accounting purposes. Before downloading the device's information to the IRS for tax-filing purposes, the device's output could be checked by practitioners, much the way practitioners double check the output from personal financial software today.
The Downside. Infotech's impact on tax practice should be obvious at this point. How often do tax practitioners act as intermediaries? That is the extent that disintermediation will erode tax practice. Low-end tax compliance, the preparation of simple returns, is an intermediate service. When preparing low-end returns, CPAs take information from a client, reformat it, and give it back to the client for filing with the government. What about technology substitution? Tax preparation is a service being provided by ever more sophisticated tax software. Also, the IRS is working very hard to eliminate paper and encourage direct e-filing by taxpayers. All three infotech factors come into play with the worldwide web. There are already web sites, some established by CPA firms, that offer tax preparation over the Internet. Check out http://www.taxattack.com. Tax compliance will be hard-hit by infotech, but the tax compliance part of tax practice will not be wiped out. There is still value added by practitioners helping clients determine the relevance of their accounting information to the government. But at the same time it probably has the lowest value-added, the lowest profit margin of the three parts of tax practice, and, therefore, at greatest risk from infotech.
The Upside. That's the downside of infotech. There is a tremendous upside as well. Infotech is the vehicle that will allow tax practitioners to capitalize on new service opportunities. (See Exhibit 1, The Roth IRA: A Nearly Lost Opportunity?) CPAs will develop the instinct to identify new service opportunities as they arise, and infotech will give CPAs the ability to quickly respond, beating out the competition.
The current income-tax-based tax system does the job of raising over 1 wQ trillion dollars annually; but, two serious problems have developed. First, it has become very inefficient, which manifests itself in the need for relatively ordinary citizens and businesses to seek assistance to comply. Nearly half the individual income tax payers hire tax preparers. Estimates of the cost to comply with the tax system are $157 billion and higher. This is easy to believe when taxpayers need to compute their taxes under two different tax systems (regular tax and alternative minimum tax), while coping with numerous phase-outs. Although upper-income taxpayers benefit from professional assistance that includes tax and financial planning advice, assistance clearly should not be necessary for lower-income taxpayers. Still, millions of lower income taxpayers pay for help to avail themselves of the earned income and child care credits; this just should not have to be the case.
Not so very long ago, the inability of average citizens to understand a statute marked it as bad legislation. Placing half the taxpayers in need of expert advice to understand the tax law says to some that the tax code is no longer a good law.
Second, many believe the tax system has become overly intrusive. Congress picked up on the public's concern at last year's Senate hearings into IRS overreach. The public reaction to economic reality auditing also exemplifies concern that Americans are permitting too much intrusion into individual affairs in the name of maintaining the public's fisc. Nevertheless, tax administrators have an inconceivable amount of revenue to collect each year. Raising this much money means some reluctant taxpayers will get pushed around.
Why this inefficiency and intrusiveness? The tax code's role in the political system is not simply to raise revenue; it is an important political "product." Politicians can be viewed as being in the business of government. The products they offer include new small business centers, hospital grants, running interference with regulators, and, yes, changes in the tax law. Tax code changes, like other government largesse, combine concentrated benefit with disbursed effect, meaning that a taxpayer for whom a tax law change is engineered through Congress receives a tangible, measurable benefit, while everyone else fails to notice that their tax bills increase a few cents. Over time, this process leads to a highly complex, and therefore very inefficient, tax code.*
As for intrusiveness, the causes lie in complexity, 1970s' inflation and 1980s' deficits. A complex tax law is trickier to comply with and more taxpayer mistakes occur. These errors trigger fear-inducing IRS notices. Inflation led to "bracket creep" in the 1970s before most of the tax code was indexed for inflation. Bracket creep shoved lower- and middle-income taxpayers into middle- and upper-income brackets. Complexity and bracket creep increased the fear if not the reality of increased noncompliance, and Congress responded by increasing its emphasis on fear-inducing penalties. Deficits led to increased pressure on the IRS to collect more taxes, and several arguably unwise administrative decisions were made to ratchet up the thoroughness of IRS audits.
The tax legislative picture is a bit like a jigsaw puzzle. Here are the pieces:
* The voters think the tax code is unwieldy and unfair.
* The tax code's bloat has led to a frustrated and frustrating administration of the law.
* Roughly half the people need assistance to comply with the tax law.
* Tax professionals are only able to advise clients with the assistance of sophisticated computer software.
* Politicians cannot realistically fidget much more with the tax code because it is already near the limits of human comprehensibility. The "product line" is becoming mature.
* Still, politicians are loathe to surrender an important means of providing benefits to their constituents.
How do the pieces of this legislative puzzle fit together? Frankly, the pieces could fit together several ways, with each arrangement leading to a different interpretation. One reading of the tea leaves is that the country is moving toward a radical tax simplification. This would move everyone back to square one, and then the effort (to re-complicate the tax law) could begin again. This is not to suggest that a grand conspiracy has plotted out this approach, only that in the natural order of things (if anything about politics or taxes can be described as "natural") the U.S. may be at the point of scrapping the current tax code for something much simpler to understand and administer.
Currently, the most popular suggestions for fundamental tax reform are the flat tax and a national sales tax. The flat tax is primarily a tax on adjusted gross income, with interest, dividends, and capital gains fully exempt. Business income is computed on a separate business return rather than on a schedule C. All businesses, including partnerships and S corporations, would file the same return. Under the flat tax, there would still be a great deal of tax compliance work, though CPAs might not need a computer for much of it.
The sales tax proposal is different. Tax would be collected at the point of sale. The state rather than the Federal government would be in charge of administration.
If fundamental tax reform does happen, a lot, though certainly not all, of the tax compliance work CPAs currently do will simply wither away. Are CPA firms prepared to react to a possible loss of 40% to 60% of their tax compliance practice in a single year?
Two economic issues bear particular mention when exploring the future of tax practice. First, competition for tax clients is much more pronounced than a generation ago. Infotech has been part of the cause of this in that it is easier for CPAs to start new full-service firms. But tax practice, unlike auditing, is not limited to CPAs, and infotech has also made it easier for non-CPAs to compete in tax practice. At the most sophisticated end of tax practice, law firms are becoming more aggressive at touting the attorney-client privilege to CPAs' clients. Some banks are offering tax services out of their trust and pension departments. And of course, there is American Express Tax and Business Services, competing for middle-market attention while adding a whole new meaning to the concept of a full-service CPA firm.
A second economic issue that will impact tax practice is the loosening up of restrictions on nontraditional billing arrangements. The AICPA under pressure from the Federal Trade Commission removed prohibitions against contingent fees and commissions (except for attest services and the filing of original and certain amended tax returns). Many state regulators have followed suit. In states where regulators have opened the door for nontraditional fee arrangements, a great deal of flexibility in the design of new services is now available.
Applying Tax Competencies to the New Practice Environment
When performing tax services, CPAs tap into a number of core values--trustworthiness, independence in attitude, and objectivity--as well as core competencies (skills sufficiently developed to marshal in offering services to the public), including--
* understanding how business works
* firm grasp on the trends in the local economy
* ability to understand and interpret statutory language
* legal and accounting research skills
* negotiation skills
* networking skills
* ability to distill the essence of a
* communications skills
* ability to foresee results of business ideas
* assessing business risks
* valuation skills
* selling skills
* tax expertise
CPAs use various mixes of these competencies to offer tax compliance, planning, and representation services. If they strengthen and emphasize some of the competencies they can add entirely new services to their practice. The CPA Journal gathered a panel of distinguished tax practitioners in 1997 to discuss the future of tax practice and what new services they were interested in offering. Exhibit 2 lists the 24 service areas they identified. Each of these services call upon one or more of the listed competencies. Some CPA firms are already beginning to offer these services. Here are a few examples.
Business Brokering. Business brokering is what Big 6 mergers and acquisitions departments are doing on a grand scale. This is the service of putting together the business owners who are looking to sell their business with those interested in buying. It calls into play--
* an understanding of the tax law, to know how the deals should be structured
* ability to see the meaning behind numbers used in business
* understanding of how business works
* firm grasp on the trends in the local economy
* negotiation skills
The fee for a business brokering may very well be a commission, so before entering this business, a CPA needs to make sure his or her state's regulators permit CPAs to take commissions.
Fairness Opinions. A CPA's client is about to enter into an important business deal. The legal documents are flying back and forth and the client likes and trusts her lawyer. Just the same, she would like to have a second opinion that the deal makes sense for her business and the legal documents fairly represent the business deal she has negotiated. She wants a fairness opinion. And she knows her CPA has demonstrated the competencies needed to offer such an opinion. But does the CPA? What are the needed skills?
* Understanding how business works
* Ability to distill the essence of a business transaction
* Communications skills
* Ability to foresee results of business ideas
* Ability to assess business risks
The end product of this service is an oral or written opinion that the deal makes sense for the client and the documents capture the essence of the deal. Because there are no specific professional standards dealing with such opinions, the CPA rendering a fairness opinion should do so with a great deal of professional care. The liability risk for such an opinion improperly given is high.
Property Tax Abatement. This business is typically rewarded with contingent fees. CPAs are beginning to become involved in property tax abatement because it is such a natural outlet for competencies they already have, including--
* negotiation skills
* communication skills
The Next Generation of Tax Practitioners
What is needed: nimbleness.
What will tax practice be like a generation from now? It is a fair bet that less effort will be spent on tax compliance. This is because compliance is exactly the type of intermediate service that computers are either eliminating or turning into low-pay, clerical functions. Tax planning will still be strong because people will always look for ways to arrange their affairs to minimize their taxes, whether they are burdened by a sales tax, a flat tax, a value-added tax, or whatever. Tax representation will still be strong, because, again, there will always be human and systemic errors to clear up between the taxpayer and the tax collector.
But these services may not be sufficient to keep the tax practitioner busy in the manner to which he or she is accustomed. So finding other services to offer that tap into skills already in abundance will be essential. The accumulation of wealth in this country is at a time like no other and will provide a myriad of opportunities for the CPA. Therefore, the tax practitioner's skills and competencies will continue to have value in such areas as intergenerational planning, estates and trusts, financial planning, and employer benefit planning. Practitioners will tend to specialize on services that have a narrower appeal than compliance services do today.
A cover of The CPA Journal several months back asked if the future of CPA practice looks bleak. Tax practitioners would answer that it will only be bleak for those CPAs who insist on performing the same services tomorrow that they performed yesterday. The future is glaringly bright for CPAs who anticipate future service needs and marshal their formidable set of competencies to meet those future needs. *
James A. Woehlke, LLM, CPA, is Director of Tax Policy of the NYSSCPA and Technical Editor (Taxes) of The CPA Journal.
*This economic approach to understanding the political system is the type of analysis offered by the "public choice" school of economics founded by Nobel prize-winning economist James M. Buchanan. The author thanks Dan Mitchell of the Heritage Foundation for his comments on the economics portion of this article.
©2009 The New York State Society of CPAs. Legal Notices
Visit the new cpajournal.com.