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Constructive Cost Models for Evaluating Financial Tax Return Workflow Processes. Colfax L. C. Selby Rice & Company CPA’s Inc. and St. Margaret’s Episcopal School San Juan Capistrano, CA. Research Investigates Constructive Cost Modeling for Financial Problem Domains.

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constructive cost models for evaluating financial tax return workflow processes

Constructive Cost Models for Evaluating Financial Tax Return Workflow Processes

Colfax L. C. Selby

Rice & Company CPA’s Inc. and

St. Margaret’s Episcopal School

San Juan Capistrano, CA

research investigates constructive cost modeling for financial problem domains
Research Investigates Constructive Cost Modeling for Financial Problem Domains
  • Synergy enables understanding of key empirical relationships for workflow effort in financial problem domains

Build on success in constructive cost modeling for systems and software

Understand financial workflow processes

Exploit hands-on experience at CPA firm processing tax returns

goal is to improve understanding workflow of tax return processing using constructive cost modeling
Goal is to Improve Understanding & Workflow of Tax Return Processing Using Constructive Cost Modeling

Overview

  • Describe U.S. Federal income tax return volume and complexity
  • Define constructive cost model for predicting effort for tax return processing
  • Apply constructive cost model to tax return processing in a typical CPA firm and describe benefits
  • Summarize conclusions
individual income taxes provide the largest source of revenue to the federal government
Individual Income Taxes Provide the Largest Source of Revenue to the Federal Government

Individual federal income taxes were 39% of federal revenue in 2006

Corporate federal income taxes were 13% of federal revenue in 2006

Source: Federal Form 1040 instructions 2007

federal government supports the processing of millions of individual income tax returns annually
Federal Government Supports the Processing of Millions of Individual Income Tax Returns Annually

138 million individual federal income tax returns filed in 2007

Over $1.3 trillion collected (average of $9837 per return)

Source: www.irs.gov/taxstats

individual federal income tax returns are often complex and include many supporting forms
Individual Federal Income Tax Returns are Often Complex and Include Many Supporting Forms

138 million total individual federal income tax returns filed

49 million filed Schedule A (Itemized deductions)

17 million filed Schedule E (Supplemental income)

4 million filed Form 5695 (Residential energy credits)

8 million filed Form 6251 (Alternative minimum tax)

Source: www.irs.gov/taxstats

most individuals use professionals to prepare federal income tax returns
Most Individuals Use Professionals to Prepare Federal Income Tax Returns

Overall average time spent to prepare tax returns is 26.4 hours

  • Due to complexity and other reasons, 59.2% of individuals use professionals to prepare federal income tax returns
  • How can we better understand the effort required and improve the preparation workflow process?

More complex tax returns required an average of 56.9 hours

Source: Federal Form 1040 instructions 2007, www.irs.gov/taxstats

research defines initial constructive cost model for predicting effort for tax return processing
Research Defines Initial Constructive Cost Model for Predicting Effort for Tax Return Processing
  • Research is based on hands-on experience and interviews at Rice & Company CPA’s Inc. in San Juan Capistrano, California where thousands of tax returns are processed each year
  • Research was performed over an 18-month period while I was a part-time employee at Rice & Company CPA’s Inc.
  • The initial model version is as follows:

E = A * GB *  Fi

where

  • E is the financial tax return preparation effort in person-hours
  • A is a linear calibration constant
  • G is the person’s gross income from all sources in dollars
  • B is an exponential calibration constant
  • Fi are multiplicative “cost driver” factors
research estimates initial values for multiplicative cost driver factors f i
Research Estimates Initial Values for Multiplicative “Cost Driver” Factors Fi
  • F1 = Degree of supplementary forms and schedules required
    • Very low (0.5) = Zero supplementary forms and schedules
    • Low (0.75) = Only Schedules A and/or B
    • Nominal (1.0) = Schedules A and/or B plus at least one but no more than two other supplementary forms and schedules, such as Schedules C, D, or E
    • High (1.25) = Schedules A and/or B plus at least three but no more than five other supplementary forms and schedules
    • Very high (2.0) = Schedules A and/or B plus at least six other supplementary forms and schedules
  • F2 = Degree of supporting documentation and statements, such as W-2, 1099, and K-1
    • Low (0.75) = 0 to 5 items
    • Nominal (1.0) = 6 to 10 items
    • High (1.25) = more than 10 items
  • F3 = Degree of income sources
    • Low (0.75) = wages only
    • Nominal (1.0) = wages plus interest and/or dividends
    • High (1.25) = wages plus interest and/or dividends plus capital gains/losses, partnerships, royalties, stock options, and/or related items
research estimates initial values for multiplicative cost driver factors f i continued
Research Estimates Initial Values for Multiplicative “Cost Driver” Factors Fi (continued)
  • F4 = Degree of deduction sources
    • Low (0.75) = standard deduction only
    • Nominal (1.0) = itemized deductions
    • High (1.25) = itemized deductions plus depreciation, tax credits, and/or related items
  • F5 = Necessity of calculating and/or filing the Alternative Minimum Tax (AMT)
    • Nominal (1.0) = No AMT calculation required
    • High (1.5) = AMT calculation required
studies apply constructive cost model to analyze tax return processing in a typical cpa firm
Studies Apply Constructive Cost Model to Analyze Tax Return Processing in a Typical CPA Firm
  • CPA firms can organize workflow by customers

workflow

Customer 1

Customer 2

Tax returns inflow

Tax returns outflow

Customer 3

Etc.

  • Or CPA firms can organize workflow by type of tax processing

workflow

Tax credits

Etc.

Wages

Capital gains

Tax returns inflow

Tax returns outflow

constructive cost model reveals benefits of hybrid workflow organization for tax return processing

workflow

Constructive Cost Model Reveals Benefits of Hybrid Workflow Organization for Tax Return Processing
  • CPA firms can organize workflow by hybrid approaches to take advantage of customer-specific processing and centralized specializations

Customer 1 (F3, F4)

Customer 2(F3, F4)

Tax returns outflow

Tax returns inflow

Prep of W-2, 1099, K-1, forms, etc. (F1, F2)

Alternative minimum tax (F5)

Etc.

Customer 3(F3, F4)

Etc.

Model Factors

  • F1 = Degree of supplementary forms and schedules required
  • F2 = Degree of supporting documentation and statements, such as W-2, 1099, and K-1
  • F3 = Degree of income sources
  • F4 = Degree of deduction sources
  • F5 = Necessity of calculating or filing the Alternative Minimum Tax (AMT)
conclusions highlight benefits of constructive cost modeling for tax return workflow processes
Conclusions Highlight Benefits of Constructive Cost Modeling for Tax Return Workflow Processes
  • Research was performed over an 18-month period while I was a part-time employee at Rice & Company CPA’s Inc.
  • Defined constructive cost model for predicting effort for tax return processing
    • Estimated initial values for the multiplicative cost driver factors F1 through F5 that quantify the effects of different elements of the individual tax return preparation process
    • Research experiments are underway to measure actual values in order to improve model accuracy
  • Applied constructive cost model to analyze tax return processing in a typical CPA firm
  • Analysis of constructive cost model revealed benefits of hybrid workflow organizations for tax return processing
    • Take advantage of customer-specific processing and centralized specializations
  • Rice & Company CPA’s Inc. recognized my contributions by giving me the Employee-of-the-Year Award