(MONEY Magazine) – Whether you're just starting to think about preparing your '96 tax return or have already filed, this story is sure to give you a jolt. Last November, MONEY tested the knowledge and ability of tax preparers across the country by getting 45 seasoned pros to prepare a return for the fictional Baker family. The alarming results in our seventh such tax preparers' test: No two pros came up with the same tax total. Furthermore, not a single preparer calculated what we believe to be the correct federal income tax--$42,336--as determined by the test's author, MONEY tax editor Mary L. Sprouse. In fact, fewer than one in four (24%) came within $1,000 of that figure. The others said the Bakers owed anywhere from $36,322 to $94,438, a staggering 160% variance--the second widest dollar spread in the seven-year history of our tax test. Thus, depending on who prepared their return, the Bakers would have overpaid by a painful $52,102, or all but begged for an audit by underpaying as much as $6,014.

Don't pin all the blame for this tax mess on the professional tax preparers. A good portion of the screwups in the nation's tax returns rests with America's incredibly dense, ever-changing tax law. Says Rep. Bill Archer (R-Texas), chairman of the tax-writing Ways and Means Committee: "Mistakes are inevitable so long as we keep our ridiculously complicated tax code."

The implication for you is obvious. Chances are your return is so riddled with errors--even if it's one of the 48% that will be handled by a professional--that you're paying as much as 25% too much income tax. Indeed, over the history of the MONEY test, returns overstating the tax due came in 25% too high on average. Pros who understated the tax due were 10% too low on average. Such an understatement on your return could make you a prime target for a deficiency notice or audit, plus the IRS' accompanying interest and penalties.

This special report will help you pay the lowest legal amount of tax possible by highlighting the trouble spots our pros ran into, so you can learn from their mistakes; pointing you to not-so-obvious deductions you can take to lower your tax bill (page 88); telling you how to sidestep an IRS audit (page 90); and showing how one woman can slash her tax bill by 16% (page 92). We'll also explain how to amend your '96 return if you already filed.

First, the highlights from our test:

--Most of the returns were marred by outright errors. Mistakes ranged from seemingly simple matters such as overlooking taxable dividends or miscalculating the child-care credit, to complex ones like determining the taxable portion of stock options and inheritances. Consider: Of the 45 contestants, 23 missed the mark by more than 10%, and of that misguided majority, three were off by 20% to 30%, while 14 blew it by more than 30%.

--The "right" amount of tax depends as much on a tax pro's judgment calls as on the tax law itself. David M. Walther, a tax attorney at the certified public accounting firm Mueller Prost Purk & Willbrand in St. Louis, who vetted the test for MONEY, predicted that there would be deviation from the $42,336 target tax because of ambiguities in the tax law. Sure enough, several of the returns whose tax tab clustered around the target diverge from the mark mainly because the pros had varying interpretations of murky areas of tax law. For example, the preparers came up with six different ways to allocate the Bakers' mortgage interest and points. "Some tax rules are so convoluted that key decisions come down to toss-ups and testosterone," says Walther.

--There was no correlation between the size of preparers' fees and how well they scored. As the table at right shows, the pros spent from four to 47 hours completing the return and would have charged the Bakers from as little as $300 to as much as a head-throbbing $4,950. The average hourly fee was $81. But six of the 10 returns with the highest tax totals were prepared by professionals with above-average fees; four of them would have billed our family $100 an hour or more.

Now meet our hypothetical family, the Bakers: Curt, 56; his wife Ann, 44, and their two children--Roy, 19, a full-time college student, and Meg, 4. In 1996, Curt took early retirement from his job as a director of strategic planning at an electronics firm and became a self-employed public relations writer. Between his corporate job and his self-employment, he ended up making $30,831 in 1996. He also received a $60,000 lump-sum payout from his 401(k) when he retired. Ann, a lawyer, switched from one corporate job to another in '96. Her income for the year: $80,900. She also inherited $30,500 from her uncle. The Bakers' investments include a mix of stocks, bonds and mutual funds that threw off $21,298 in interest, dividends and capital gains. The couple, whose joint income put them in the 36% tax bracket, own their own home, which they refinanced in February 1996.

We gave the test to 27 veteran C.P.A.s, 13 enrolled agents (a designation earned by tax pros who have worked at the IRS for at least five years or have passed a tough, two-day IRS exam) and five tax pros for whom tax-return preparation is a significant part of their professional practice. Four of the 45 volunteered; we recruited the others. H&R Block was represented by an enrolled agent; the other major tax preparation chains and the Big Six accounting firms declined to participate.

Top honors in this year's contest go to a trio of crack C.P.A.s: Mark Castellucci, 39, of Davis, Calif. (pictured on page 82); Steven Albright, 45, of Knoxville and Susan Rosenberg, 37, of Rockville, Md. Each of their tests deviated from our results in minor ways: Castellucci and Albright undershot the target tax by $26 and $9, respectively, while Rosenberg was $28 too high. (Castellucci's deviations from our model were virtually all due to judgment calls, while Albright made one outright mistake that he concedes.) And both Castellucci and Albright let Ann Baker take a deduction for $55 she spent on flowers and lunch for her secretary on Secretary's Day. But MONEY tax editor Sprouse, a former IRS audit manager, says this deduction wouldn't fly in an audit because the tax code doesn't reward job niceties unless they're directly related to the production of income. Rosenberg cost the Bakers an extra $25 in tax by lowballing a deduction for points paid on the home refinancing.

At the high and low extremes of the tally were C.P.A.s Gil Johnson, 77, of White Bear Lake, Minn. and Weldon Dickson, 57, of DeSoto, Texas. Johnson, who overstated the tax by $52,102, committed several expensive blunders. He was one of three participants who counted as income the $72,000 in 401(k) payouts that Ann dutifully rolled over into a tax-deferred Individual Retirement Account when she switched jobs. Johnson was also one of three who mistakenly said the Bakers owed tax on the $22,000 they withdrew from an IRA but redeposited in a new IRA within 60 days. (You're allowed one tax-free, penalty-free, 60-day IRA withdrawal a year.) Tax overstatement: $7,920. Johnson insists that a short-term IRA withdrawal can be used only for specified purposes, none of which applied to the Bakers. But, in fact, the tax law imposes no such restrictions.

Dickson skillfully navigated most of the test issues but undershot the tax bill by $6,014 mostly because he misinterpreted a sentence in the test. It read: "In 1996, Curt's gross receipts were $25,800, not counting a $20,000 check from a new client dated Dec. 31, 1996 that he received on Jan. 5, 1997 but for which he received a 1996 Form 1099." Dickson and one other preparer took this to mean that Curt had grossed just $5,800 in 1996 ($25,800 minus $20,000). So they failed to report $20,000 in income that was received and taxable in 1996. A full 38 preparers handled the issue correctly by reporting $25,800 as taxable income in 1996 and deferring until 1997 the $20,000 received in 1997.

Here are eight other areas that tripped up the tax pros. They could be trouble spots for you too.

--Choosing the proper tax filing status. Four preparers incorrectly decided the Bakers should send in separate returns rather than file jointly. Their thinking: By splitting the Bakers' income between two returns, one spouse could write off a larger portion of the couple's medical and miscellaneous expenses, which are deductible only once they exceed 7.5% and 2% of your adjusted gross income, respectively. Trouble is, on a separate return you're supposed to report only your own expenses. One of the four, C.P.A. Maureen Evans of Louisville, admits she was being aggressive by letting Ann fully deduct expenses that were clearly not hers alone. "I fudged," she says. "I prepare returns for my clients, not the IRS."

--Calculating the gain on a mutual fund redemption. The Bakers pocketed $62,500 when they redeemed their shares in a mutual fund in December. A full 33 preparers correctly computed the lowest possible gain on the transaction ($5,768) by using one of the allowable methods known as "first in, first out" or FIFO. But nine pros relied on a statement that the Bakers got from the fund company, which showed a gain of $8,566, computed under the alternative and, in this case more expensive, "single category" method. That resulted in a tax due of $2,398, or $783 more than under FIFO.

--Paying the nanny tax. Starting in 1995, taxpayers with household employees earning $1,000 a year or more have had to report and pay the employer's share of Social Security and Medicare taxes on their own 1040. Thus the Bakers owed tax totaling $321 on the $2,100 they paid Meg's part-time nanny. But 11 preparers omitted the tax. "I spent so many years filing the old way, I forgot the new law," said one.

--Figuring Keogh write-offs. Ann had set up a profit-sharing Keogh retirement plan, which lets you contribute annually and deduct up to 13.04% of your net self-employment income. Accordingly, 33 preparers correctly advised her to contribute $901 to her Keogh, based on the $6,906 in freelance income she earned in 1996. Tax savings: $324. But seven participants ignored the Keogh and four incorrectly computed a deductible contribution of $1,382. Ann would be allowed that much if she had a so-called money-purchase Keogh, which lets you contribute and deduct up to 20% of your net self-employment income.

--Determining whom you can claim as a dependent. In 1996, the Bakers paid $10,520 to help support Curt's 80-year-old father, Lester. But 23 tax pros mistakenly failed to claim the $2,550 dependency exemption. One criterion in claiming a parent as a dependent is that you must provide more than half his total support. A parent living in his own home, as Lester did, is deemed to have contributed to his own support an amount equal to the fair rental value of his house ($6,000 a year in his case) minus any amount others pay to maintain the home. Since the test stated that the Bakers paid $3,600 to help maintain Lester's house, the fair rental value came to just $2,400 ($6,000 minus $3,600). In fact, the Bakers did provide more than half Lester's support and were entitled to claim him.

--Cutting inheritance taxes. When Ann's 69-year-old uncle died in November, she inherited his $30,500 employer-provided retirement annuity. A megaflub award goes to the 10 participants who subjected the entire windfall to ordinary income tax, adding a painful $10,980 to the Bakers' tax bill. In contrast, 32 preparers arrived at the correct tax on the annuity, a mere $2,590, by using a special tax-saving calculation called 10-year forward averaging. This technique lets you compute the tax as if you got the money over 10 years rather than all at once. The payout qualified for averaging because Ann's uncle was born before 1936 and had not yet tapped his retirement stash.

--Avoiding penalties on 401(k) withdrawals. Nine preparers kneecapped Curt with a 10% early-withdrawal penalty on his $60,000 401(k) payout. They didn't realize that the tax law waives this penalty before age 59 1/2 if you take your money as part of an early-retirement package and are at least age 55.

--Figuring the tax on stock options. In 1996, Ann paid $22,000 to exercise nonqualified stock options that she had been granted by her employer years before. When you exercise a nonqualified option, the difference between the option price and the stock's current value is taxable as ordinary income. In Ann's case, the shares had grown in value to $30,000--an $8,000 increase that was plainly reported as income on Ann's W-2. But 11 preparers incorrectly interpreted the W-2 and ended up reporting the $8,000 both as W-2 wages and as a short term capital gain for a tax overstatement of $2,880.

--Getting a refund on Social Security tax. Because she switched jobs in 1996, Ann had too much Social Security tax withheld on her wages. Here's why: In 1996, an employee had to pay the flat 6.2% Social Security tax on wages up to $62,700, for a maximum tax of $3,887. Once you reached that level, your employer stopped withholding the tax. But if you job hopped during the year like Ann did and your combined income from both jobs exceeded the $62,700 threshold, your total withholding would be too high. The excess in Ann's case came to $1,315, which 37 preparers properly computed and claimed as a refund on line 56 of the 1040. But eight preparers muffed this computation and understated the Bakers' tax by $93.

LESSONS FOR YOU

What can you learn from the pros' disappointing performance? Follow these steps to determine whether you need professional tax help and, if so, how to choose the right preparer:

--Get up to speed yourself. You need to understand the gist of your own tax issues so you can direct your pro to problem areas. Read the sections that apply to you in tax tomes such as The Ernst & Young Tax Guide 1997 ($14.95) or J.K. Lasser's Your Income Tax 1997 ($14.95). Or take a stab at completing your return by using tax software such as Kiplinger TaxCut ($20 for Windows; $40 for the deluxe Windows or Mac version) or TurboTax ($35; $50 for deluxe). One plus: the softwares' Q&A format will help you assemble and organize your records.

--Select a pro with expertise in your thorniest tax areas. Ask friends and colleagues whose finances are similar to yours for references and talk to a handful of preparers before choosing one. Be sure to ask the pro how he or she keeps up with the tax law. Let the pro know your tax temperament as well. If you are a strictly play-by-the-rules type of taxpayer, you don't want a push-the-envelope preparer.

--Tell your pro you'd like a letter with your completed return explaining any judgment calls he or she made in gray areas of the tax law. Your preparer should cite the sources that buttress the position taken, such as court cases or IRS rulings. Remember: You're the one who will bear ultimate responsibility for what's on your return.

--Ask your pro to call you with any questions that arise in the course of completing your return. Your aim is to deter your preparer from making erroneous assumptions.

--Review your completed return carefully. Ask your preparer about any figures that seem unusually large or small. When you're satisfied, sign your 1040 and send it in. Then relax. Chances are, if you always follow these steps, you'll have many happy returns.

Reporter associate: Joan Caplin