Tax preparation automation is the use of software to file taxes. Automation makes the process easier and more accurate by pulling in your financial information automatically, calculating your debt and possible refund, and checking for mistakes to avoid issues with the tax authorities. You can also file your taxes electronically through these systems, accelerating the process further and helping you get any refunds faster. This kind of software can often connect directly with your accounting software, which organizes all your financials in one place.

All kinds of businesses automate their taxes, with the global tax software market valued at around $18.5 billion USD in 2023. Below, we’ll explain what you should know about tax preparation automation and how to choose the right solution for your business.

What’s in this article?

• How does tax preparation automation work?
  
• Benefits of automating tax preparation
  
• Challenges of tax preparation automation
  
• How to choose an automated tax preparation solution
  
• Best practices for tax preparation automation
  

How does tax preparation automation work?

Here are the core components of tax preparation automation.

• Data collection: First, tax preparation software aggregates financial data. This data can come from sources such as payroll systems, bank accounts, investment platforms, and accounting software. Advanced application programming interfaces (APIs) enable the transfer of this data into the tax software to account for all financial activities.

• Tax rule engine: Tax preparation software provides a regularly updated rule engine that reflects the latest tax laws and regulations across different jurisdictions. This engine applies these rules to the imported financial data to determine taxable events and accurately calculate the taxes owed. For businesses, it handles considerations such as depreciation, amortisation, and cross-border tax implications.

• Error detection and compliance checks: Sophisticated algorithms scan the data for inconsistencies or entries that might lead to audits, such as outlier deductions or mismatched income reports. This component reduces compliance risks and ensures that the filings adhere to current tax codes.

• Fine-tuning taxes: More advanced platforms might have a feature that suggests legal tactics to reduce tax liabilities. These could include income shifting, deduction timing, or retirement contributions. This fine-tuning uses predictive analytics and simulates future tax scenarios based on proposed actions.

• Electronic filing: Once the software prepares and reviews the returns, it electronically files them with the appropriate tax authorities. The software will also often track the return’s status and send notifications about any issues, confirmations of acceptance, and updates about potential refunds or amounts due.

Benefits of automating tax preparation

Here are some possible benefits for individuals and businesses that automate their tax preparation.

• Greater accuracy: Tax software reduces human errors in data entry and calculations by applying the latest tax rules consistently and accurately.

• Saved time: Automating routine tasks such as data collection, calculations, and form filling saves time.

• Lower costs: Tax preparation automation requires an initial investment, but it can create long-term savings by reducing manual labour and lowering the fees paid to external tax preparers.

• Compliance: Tax software stays up-to-date with the latest tax codes and regulatory changes to help users remain compliant and avoid penalties for non-compliance.

• Financial insight: Tax software often includes analytics features that give insight into financial health, tax liabilities, and savings opportunities.

• Security: High-quality tax software uses strong security measures to protect sensitive financial data and personal information.

• Simpler filing process: Electronically filing with tax authorities is easier with tax software, often producing faster processing times and quicker refunds. The software can also handle complicated tax scenarios without the need for deep tax knowledge from the user.

• Scale: As transactions increase or as the business expands into new tax jurisdictions, tax software can accommodate these changes without additional investments.

• Ongoing tax assistance: Tax software can monitor the tax implications of financial decisions throughout the year for better tax planning and liability management.

Challenges of tax preparation automation

Here are some challenges of automated tax preparation.

• Up-front costs and integration: Tax automation software can involve substantial up-front costs, and integrating it with existing financial systems and workflows can be time-consuming and require technical expertise.

• Data security: Handling sensitive financial and personal information requires strong security measures to protect against data breaches and cyber threats.

• User experience: While tax software can help simplify the tax filing process, some users might find it difficult to navigate. The user interface must be intuitive and accessible enough for those with limited tax knowledge.

• Data input: Automated systems rely heavily on the input data being accurate and comprehensive. If the initial data inputs are incorrect or incomplete, that can lead to errors in tax calculations and filings.

• Over-reliance on technology: Users can become overly reliant on automated systems and overlook the need to understand their own financial situations and tax obligations. They might disconnect from business finances and have a reduced ability to manually verify tax-related decisions.

• Technical support: As with any software, users might require technical support and training. Providing this can be resource-intensive for businesses.

• Exceptions: Tax software might not always handle rare or unique tax scenarios effectively. Customising solutions to handle such cases can be complex and costly.

• Multinational tax filings: Multinational corporations must follow different countries’ tax codes and filing procedures. These companies must choose automated systems that can adapt to a wide range of regulatory environments.

• Potential for errors: Automation can introduce errors if users don’t properly design, test, and update the software. For example, if the software misinterprets tax laws, it could lead to incorrect filings – which could have legal and financial consequences.

How to choose an automated tax preparation solution

To choose the right solution for tax preparation automation, you’ll need to evaluate whether the software meets your business needs. Here’s a quick guide to the selection process.

Determine your business needs

• Consider the size of your business and the complexity of your tax situation. Larger businesses or those with multiple income streams, international transactions, or specialised industry regulations might need more advanced software.

• Assess how well the software integrates with existing financial systems such as accounting software, payroll services, and customer relationship management (CRM) systems.

• Think about who will use the software (e.g., in-house accountants, a finance team, external tax professionals) and what their specific needs are regarding usability and functionality.

Research available options

• Research the most popular tax preparation software for businesses. Seek reviews, testimonials, and case studies.

• Outline each software’s key features. These might include data import and export capabilities, multi-state filing, automatic tax updates, compliance checks, or analytics.

• Confirm that the software includes strong security measures such as data encryption, secure user authentication, and regular security audits.

Evaluate compliance

• Verify that the software complies with the latest tax laws and regulations applicable to your business.

• Check how frequently the software is updated for new tax laws and what its update process is. Ensure that the software provider has a reliable track record of adapting the software to tax changes.

Consider scale and support

• Choose software that can adapt to your business growth. Make sure it can handle increased transactions and potential expansions into new tax jurisdictions without performance issues.

• Evaluate the level and quality of customer support provided. Check if the provider offers training resources such as tutorials, webinars, and user manuals to help your team use the software.

Test usability and interface

• Many software providers offer free trials or demos. Use these to test the software’s interface and usability to see if it meets your business needs.
  

Analyse costs and benefits

• Determine the software’s pricing structure, which could be a one-time purchase, a monthly subscription, or based on the volume of filings. Compare this against the expected return on investment such as time saved, error reduction, and improved compliance.
  

Gather feedback and decide

• If possible, gather feedback from the team members who participated in the trial period about their experiences with the software.

• Use all insight and feedback to make a well-informed decision that balances functionality, cost, support, and scale.

Best practices for tax preparation automation

These best practices can help you get the most out of your tax preparation software:

• Perform advanced data validation: Develop custom validation rules that go beyond basic error checking. Use predictive analytics to identify patterns that could indicate discrepancies, or use refinement opportunities and machine learning algorithms to improve data quality over time.

• Use artificial intelligence (AI) for tax planning: Use AI to predict tax implications based on varying business scenarios. This can help with strategic financial planning and preparation of changes in tax liability under different economic conditions.

• Customise your software: Instead of relying on off-the-shelf solutions, develop custom modules that support the unique aspects of your business structure or industry. These might include specialised procedures for international tax compliance, complicated capital gains calculations, or industry-specific tax incentives.

• Choose real-time data processing: Shift from batch processing to real-time data processing for immediate tax record updates and insight. This allows you to make more timely decisions based on the most current financial information, and it can improve your reactive and proactive tax planning.

• Improve data integrity with blockchain: Explore the use of blockchain technology to secure tax data transactions for greater data integrity and traceability. This can be particularly advantageous in audit scenarios, as the blockchain provides unchanging records and a clear audit trail.

• Set role-based access controls: Implement sophisticated access controls that limit who can access sensitive tax data, and track and manage changes made by each user. This creates more accountability and boosts security by minimising unauthorised access and potential for internal fraud.

• Prepare for regulatory changes: Develop a system for quickly adapting to regulatory changes. This might include automated alerts for new tax laws, integration with legal analysis tools, or software development practices to quickly implement changes in the automated system.

• Conduct detailed risk assessments: Regularly perform thorough risk assessments on your tax processes and automation tools. Use advanced statistical methods to determine risk factors and potential impacts to the business, and then adjust tactics accordingly.

• Incorporate human oversight: Pair expert human oversight with automation to handle complicated issues, provide strategic insight, and check the automated outputs. This hybrid approach maximises effectiveness by combining automation’s speed and accuracy with the nuanced understanding of experienced tax professionals.

• Improve the process over time: Use agile methodologies to iteratively refine and improve the automated system. Inform this continuous improvement cycle using feedback loops from tax audits, user experiences, and system performance analytics.