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
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Research Investigates Constructive Cost Modeling
for Financial Problem Domains
Build on success in
constructive cost
modeling for
systems and
software
Understand
financial
workflow
processes
Exploit handson experience
at CPA firm
processing tax
returns
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 Synergy enables
understanding of
key empirical
relationships for
workflow effort in
financial problem
domains
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
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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
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Source: Federal Form 1040 instructions 2007
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)
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Source: www.irs.gov/taxstats
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)
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Source: www.irs.gov/taxstats
Most Individuals Use Professionals to Prepare
Federal Income Tax Returns
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?
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Source: Federal Form 1040 instructions 2007, www.irs.gov/taxstats
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
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Research Estimates Initial Values for Multiplicative
“Cost Driver” Factors Fi
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 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 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
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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
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Etc.
Tax credits
Capital gains
Tax returns inflow
Wages
workflow
Tax returns outflow
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 2 (F3, F4)
Customer 3 (F3, F4)
Etc.
Etc.
Customer 1 (F3, F4)
Alternative minimum tax
(F5)
Tax returns
inflow
Prep of W-2, 1099, K-1,
forms, etc. (F1, F2)
workflow
Tax returns
outflow
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)
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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
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