0 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

1 Research Investigates Constructive Cost Modeling for Financial Problem Domains  Synergy enables understanding of key empirical relationships for workflow effort in financial problem domains Understand financial workflow processes Build on success in constructive cost modeling for systems and software Exploit hands- on experience at CPA firm processing tax returns

2 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

3 Individual Income Taxes Provide the Largest Source of Revenue to the Federal Government Individual federal income taxes were 39% of federal revenue in 2006 Source: Federal Form 1040 instructions 2007 Corporate federal income taxes were 13% of federal revenue in 2006

4 Federal Government Supports the Processing of Millions of Individual Income Tax Returns Annually Source: million individual federal income tax returns filed in 2007 Over $1.3 trillion collected (average of $9837 per return)

5 Individual Federal Income Tax Returns are Often Complex and Include Many Supporting Forms 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: million total individual federal income tax returns filed

6 Most Individuals Use Professionals to Prepare Federal Income Tax Returns Source: Federal Form 1040 instructions 2007, Overall average time spent to prepare tax returns is 26.4 hours More complex tax returns required an average of 56.9 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?

7 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 * G B *  F i 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  F i are multiplicative “cost driver” factors

8 Research Estimates Initial Values for Multiplicative “Cost Driver” Factors F i  F 1 = 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  F 2 = 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  F 3 = 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

9 Research Estimates Initial Values for Multiplicative “Cost Driver” Factors F i (continued)  F 4 = 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  F 5 = Necessity of calculating and/or filing the Alternative Minimum Tax (AMT)  Nominal (1.0) = No AMT calculation required  High (1.5) = AMT calculation required

10 Studies Apply Constructive Cost Model to Analyze Tax Return Processing in a Typical CPA Firm  CPA firms can organize workflow by customers Customer 1 Customer 2 Customer 3 Etc. Tax returns inflowTax returns outflow  Or CPA firms can organize workflow by type of tax processing workflow Tax returns inflowTax returns outflow workflow Tax creditsCapital gainsWagesEtc.

11 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 (F 3, F 4 ) Customer 2 (F 3, F 4 ) Customer 3 (F 3, F 4 ) Etc. Tax returns inflow Tax returns outflow workflow Alternative minimum tax (F 5 ) Prep of W-2, 1099, K-1, forms, etc. (F 1, F 2 ) Etc. Model Factors  F 1 = Degree of supplementary forms and schedules required  F 2 = Degree of supporting documentation and statements, such as W-2, 1099, and K-1  F 3 = Degree of income sources  F 4 = Degree of deduction sources  F 5 = Necessity of calculating or filing the Alternative Minimum Tax (AMT)

12 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 F 1 through F 5 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