Just before April 15th of last year, a married couple I am acquainted with asked me to help them with their 2017 tax return. I agreed to do so for free (note: I am not registered as a paid tax preparer and my name was not listed anywhere on the return). He is a minister and receives a housing allowance. His church does not withhold anything from his paychecks. Also, he has not at any point applied for an exemption from SE tax via Form 4361.
Their AGI was low enough to qualify for TurboTax Free File, so we sat together and used that to prepare their return. When we got to the section on Self-Employment tax, the software asked a question about which income they would pay self-employment taxes for. There were several options, two of which were something along the lines of "Pay SE taxes on wages only" and "Pay SE taxes on both wages and housing allowance".
We did not immediately know how to answer this question and didn't have much time to research. We had a copy of their 2016 return at hand, so I decided to consult that to save time, instead of researching the IRS documentation. They had paid a professional to prepare the 2016 return, so I assumed it would correctly handle this. For that year, they had only paid self-employment taxes on the wages, so we answered the same for the 2017 return.
Fast forward to this year. I am helping them once again, and we have a bit more wiggle room time-wise before the filing deadline. So when this question came up, I decided to research it properly to be certain. Based on what I've read, it is fairly obvious to me that they should have been paying self-employment taxes on the housing allowance all along.
To see how large the problem might be, I went back through some of their older documents. In 2014 and 2015, it seems they paid SE tax on their housing allowance. At that time, they were paying someone else to do their taxes. They used a different preparer for 2016 only.
I am advising that we amend their returns for both 2016 and 2017. Ballpark estimate is that they underpaid by about $4K each year (EDIT: "underpaid" is probably the wrong term to use here. "Under-calculated" seems more appropriate. They received a $5K refund from the 2016 return and a $2K refund last year.) To my knowledge, they have sufficient savings to cover the bill in full.
I think we will be able to amend the 2017 return using TurboTax, but we will probably need to do the 2016 1040-X and related calculations by hand. I assume there will be penalties/interest involved, and this is where my questions start to come in:
- Do they have any recourse to avoid penalties and/or interest, at least on the amount underpaid for the 2016 return, since their paid preparer made an error?
- If not, is there some free, publicly available tool to help us calculate the penalties and interest in a situation like this? Seems like a rather complex calculation, from what I've read so far...
- Should I recommend that they report this guy to the IRS or some other entity governing tax preparers?
Thanks in advance.