Offshore Outsourcing of Tax-Return Preparation
Promising Business Opportunities and Professional Standards

By Jesse Robertson, Dan Stone, Liza Niederwanger, Matthew Grocki,Erica Martin, and Ed Smith

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Outsourcing tax-compliance work overseas can enable CPAs to focus on higher-margin services such as tax consulting, to reduce labor costs, and to increase the speed of tax-return processing. With such potential benefits, CPA firms will likely join other segments in increasingly outsourcing tax-compliance services.

Some argue that outsourcing U.S. jobs overseas is un-American. Others rightfully point out that some overseas labor markets can be exploitative and contrary to American sensibilities—to the extent of exploiting indentured workers or child labor. On the other hand, some economists argue that outsourcing jobs overseas improves world labor market efficiency and U.S. labor productivity, and also reduces both world and U.S. inflation. CPAs that outsource appropriate work overseas can contribute to the economic efficiency of the United States and the world economy, and aid in the economic development of developing countries with high rates of poverty.

Offshore Outsourcing for Tax-Compliance Services

Outsourcing tax-return preparation offshore involves partnering with an outsourcing facilitator that provides the Internet interface and the access to overseas expertise, such as CAs in India, needed for offshore outsourcing. Four prominent facilitators are Commerce Clearing House (CCH), Outsource Partners International (OPI), SurePrep, and Xpitax (see Exhibit 1).

The basic process of tax outsourcing involves six steps (see Exhibit 2):

• The outsourcer gathers the client’s tax information and scans it into electronic files.
• The outsourcer uploads these files to the facilitator’s website.
• The facilitator encrypts the files and makes them available to the outsourcing partner in India.
• The outsourcing partner prepares and reviews the return, and then posts the return, workpapers, notes, and reconciliations to the facilitator’s website.
• The outsourcer downloads the completed return and documents from the facilitator’s website.
• The outsourcer reviews and signs the return, and forwards it to the client for filing.

Outsourcing in Practice

The largest CPA firms pioneered outsourcing tax preparation and other accounting services. Economists expect smaller CPA firms to follow their example. Mergers and consolidations of CPA firms will also likely increase outsourcing as firm size and client market shares increase. Businesses in the outsourcing industry also forecast significant growth of outsourcing. According to Robert W. Scott, Carly Lombardo, and Richard McCausland, in “Is the Sun Setting on Desktop-Based Tax Preparation?” (Tax Software Special Focus, The Practical Accountant, December 2003), Mike Sabbatis, vice president of business at CCH, predicted that about 100,000 tax returns would be outsourced in 2004, and David Wyle, president of SurePrep, predicted 200,000.

Tax-return-preparation outsourcing offers several potential benefits to CPA firms. It frees tax professionals’ time from performing perfunctory duties such as form filing and data entry; that time savings can be used more productively in tax and estate planning. Tax outsourcing lessens the need for temporary professional staff during the busy season. Labor rates provide a cost advantage to outsourcing tax services overseas. For example, a staff accountant earning an annual salary of $45,000 (plus 20% of salary in benefits) costs a firm about $39 per billable hour (assuming 1,400 billable hours per year). According to Carly Lombardo, in “Outsourcing Tax Prep Is In, In, In” (Accounting Technology, May 2004), some sources suggest that the current costs of outsourcing through a facilitator can be expected to result in tax-preparation costs of about $20 per billable hour.

Recruiting new accounting staff is increasingly competitive. For example, the number of undergraduate and advanced degrees awarded to accounting majors declined by 20% from 1996 to 1999. In addition, the number of candidates sitting for the CPA examination has been declining since 1993. Although there are encouraging signs of increased enrollment, temporary shortages of available U.S. tax professionals can be alleviated by outsourcing.

Outsourcing tax-preparation services overseas can also improve service by speeding the delivery of completed returns. Tax information can be transmitted instantaneously around the globe. In addition, the differences between U.S. and Indian time zones means that a return sent overseas for preparation in the afternoon can be completed after hours (daytime in India) and downloaded by the U.S. CPA the next morning. Finally, because outsourcing overseas moves tax preparation to a mostly web-based system, it can significantly reduce the volume of stored paper files.

Arguments against outsourcing overseas. One concern about outsourcing is the privacy and security risk of posting confidential client information (e.g., Social Security numbers) to a facilitator’s website. For example, some clients may not want their information sent to a third party that is not directly supervised by their CPA. Fortunately, the growth in e-filing of tax returns has spurred tighter security controls, which are also available from facilitators. Secure data facilities, private networks, firewalls, and sophisticated data-encryption techniques now mitigate online privacy and security concerns about outsourcing. Although no electronic transmission of data, including the e-filing of tax returns, can ever be completely secure, outsourcing overseas can increase privacy and security concerns because of the interjection of a third-party preparer not directly supervised by the outsourcer.

A second concern about outsourcing is that it limits the tax-preparation experience of entry-level accountants. Veteran CPAs may remember similar concerns in the 1960s and 1970s, when electronic systems replaced manual accounting systems. Newer staff accountants in offices using outsourcing may require new or expanded training to replace experience preparing returns. The role of these staff will likely involve less routine preparation work and more client interviews, expanded tax-planning engagement responsibilities, and an expanded apprenticeship period working with veteran tax consultants to review processed tax returns. Some are concerned that it will take longer for new staff to understand the tax effects of transactions because they will miss the learning that takes place when someone actually works with and comes to understand the internal logic of the forms.

Decreased staff morale and staff concerns about layoffs are also important challenges to any firm considering outsourcing. One strategy to mitigate such concerns may be to commit to not downsize existing staff as a part of an outsourcing strategy. Outsourcers may also be concerned about the quality and reliability of facilitator services and the ability to quickly correct tax-return errors. Selecting a reputable, experienced facilitator, along with negotiating a contract that ensures timely service, correction of errors, and a contract-termination provision period, can help reduce these risks.

Although outsourcers may also be concerned that political instability in the country of the facilitator may interrupt processing operations, such concerns have not prevented many large financial-service organizations (e.g., Citibank, American Express) from outsourcing operations.

Another barrier to effective outsourcing is technology capability. Hardware, data storage, software, and knowledgeable staff are required to move tax preparation from manual processing to a web-based processing system.

Finally, both clients and CPAs may have concerns about the quality of outsourced services as well as the patriotism of overseas outsourcing.

Outsourcing and Professional Standards

The CPA Code of Professional Conduct has implications for outsourcing tax work overseas. Two issues are of primary importance in considering CPAs’ ethical obligations in an outsourcing arrangement:

• Disclosure of the use of a third-party service provider to the client; and
• Supervision of the third-party service provider.

The CPA Code of Professional Conduct states that members “in public practice shall not disclose any specific confidential client information without the specific consent of the client.” The recently issued Ethics Rulings 112 (under Rule 102) and 1 (under Rule 301) clarify these responsibilities when CPAs use third-party service providers. Ruling No. 112 states that:

[B]efore disclosing confidential client information to a third-party service provider, a member should inform the client, preferably in writing, that the member may use a third-party service provider. If the client objects to the third-party provider, the CPA should provide the service without the use of the third-party provider.

Ruling 1 states that the CPA should have a client confidentiality contract with the third-party provider:

[B]efore using a service provider, the member should enter into a contractual agreement with the third-party service provider to maintain the confidentiality of the information and be reasonably assured that the third-party service provider has appropriate procedures in place to prevent the unauthorized release of confidential information to others.

Recently issued Ethics Ruling 12 (under Rule 201) addresses CPAs’ obligations to oversee the work of third-party professional service providers. The obligation to ensure that professional services include due professional care is no less when a third-party provider is used. At the same time, CPAs have no additional responsibilities in cases of third-party providers beyond those identified in existing standards. Pragmatically, this ruling suggests the necessity of documenting the adequacy of the provider’s confidentiality, security, and privacy controls, as well as compiling evidence demonstrating the competence of the provider’s professional staff. Similarly, though less explicitly, IRS Circular 230 (www.irs.gov/pub/irs-pdf/pcir230.pdf) requires tax preparers that rely on the work of third-parties to exercise “reasonable care in engaging, supervising, training, and evaluating.”

Choices

Some CPAs’ patriotism or concerns about client reaction might prevent them from outsourcing tax-preparation work. Such choices are a consequence of living in a free-market democracy that participates in the global economy. CPA firms that participate in the emerging market for outsourcing parts of professional services can expect in many cases to reap significant financial benefits themselves and to participate in the economics of the global market.

The authors are grateful to Cyndi Vines, David Hulse, and Teresa Stephenson, of the University of Kentucky, and to Deborah Harrington, of Deloitte LLP, for comments and suggestions on this article.

For additional discussions of ethical issues in outsourcing, see “The Ethical Dilemmas of Outsourcing,” by Steven Mintz (The CPA Journal, March 2004), and “Outsourcing Income Tax Returns to India: Legal, Ethical, and Professional Issues,” by Richard G. Brody, Mary J. Miller, and Michael J. Rolleri (The CPA Journal, December 2004).