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The relation between the use of tax preparers and taxpayers' prepayment position

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Since 1943, the U.S. Internal Revenue Code (IRC) has required prepayment of federal individual income taxes consistent with a pay-as-you-go approach. Employer-withholding from salaries and wages has been the principal collection and delivery mechanism for these prepayments, with a small portion coming via estimated tax payments. In addition to accelerating the collection of tax, the withholding system greatly reduces the opportunities for evasion. Because of the important role played by the withholding system, it has been characterized as "the backbone of the U.S. individual income tax" (Pechman 1987, 71).(1)

The prepayment level determines the taxpayer's "prepayment position' when filing the tax return: if total prepayments exceed tax liability, the taxpayer is entitled to a refund; if tax liability exceeds total prepayments, the taxpayer has a balance due to the Internal Revenue Service (IRS). Prepayment position has been found to be associated with several taxpayer choices that have important policy implications. In particular, there is persuasive evidence that taxpayers in a balance due position are less compliant than those in a refund position (Clotfelter 1983; Chang and Schultz 1990; White et al. 1993). The 1992 decision by the Bush Administration to reduce the amount of taxes withheld, thereby potentially increasing the number of taxpayers in an under-withheld position, may have inadvertently increased noncompliance. In addition, analysis of tax return data indicates that taxpayers in a balance due position are more likely to contribute to an Individual Retirement Account (Feenberg and Skinner 1989; Long 1990).

The purpose of this paper is to provide empirical evidence on the relation between taxpayers' use of a tax preparer and taxpayers' prepayment position. Because prepayment position is a function of two variables, tax liability and total prepayments, we also examine the relation between the use of preparers and total prepayments. To perform the empirical analysis, we...