Tax Planning Vs. Tax Preparation: What's the Difference?
“Intelligent planning is essential for success in any undertaking designed to accumulate riches” -- Napoleon Hill
Every tax season, without fail, a client meets with his tax professional and drops the cliché, “make magic happen!” While I love to think of myself as a tax season wizard-- crafting enchanting spells on tax documents while twisting my beard betwixt my spindly fingers-- only so much “magic” can happen during tax season as the damage has been done at that point. Are taxpayers just stuck accepting whatever fate their tax year bestowed upon them? Of course not! While tax preparation services mostly focus on ensuring compliance with government regulations and reducing tax liability as best as possible, tax planning services is where tax professionals really earn their fees.
You might be now thinking, “wait, is my accountant not tearing apart every line of the tax code to save me every dollar I deserve? What am I paying them for then?” While most tax professionals try to uncover the obvious opportunities, the more complex tax strategies require careful plans to ensure you get to keep every dollar you deserve. So, what is tax planning?
What is a tax plan?
Tax planning IS a comprehensive collection of your financial information to identify and implement mechanisms to lawfully reduce taxes-- by increased deductions or tax advantaged income-- that fit your personal financial goals. Expect a deep dive into what it is you do, what you have, and where you are trying to go. Remember, your goals should drive the plan. Example: if having access to your money is important, locking it away into retirement plans for potentially decades may not be a wise tax strategy.
What it isn’t
It is NOT tax prep. I say that to say, expect your tax plan and your tax preparation to be two separate engagements. It is also not an end-all-be-all. If your circumstances or the laws change, old plans may need to be updated. Tax planning is not a last-minute plea to your accountant on April 14th to “come up with” ways to get rid of your tax liability (aka magic).
Who needs planning?
Most taxpayers should go through the tax planning process as a healthy part of financial planning process regardless of income, job, wealth. Don’t have a financial plan in place? Don’t worry. Tax planning is often advised if any of the following events have/will happen:
First, have you started a new business, recently become self-employed, or made a significant investment in a new business? Simply put, the tax code tends to favor those who own businesses. Small or large, actively or passively involved, most business owners and investors have more opportunities to develop tax advantages than the typical “employee.”
Second, are you expecting significant changes to income or assets? Whether a pick-up in sales, planning to sell assets or acquire new assets, it usually a good idea to sit down with your tax accountant to plan out how this will affect you. Remember: little can be done after the fact. Be proactive and get ahead of the tax monster.
Third, has there been significant changes to the U.S. tax law that might have a material impact on your personal tax situation (i.e. Tax Cuts and Jobs Act)? Now might be as good a time as ever to sit down with your tax professional. And by “now” I mean, the sooner the better. The current law has several taxpayer friendly provisions that will “sunset” in several years. Don’t miss out on giving yourself a raise because of procrastination.
“So, what’s in it for me?” The obvious benefit of implementing a successful tax strategy is easy to understand: pay less tax! But, saving to save is useless unless there is a reason to save. The benefits of additional tax savings are as innumerable as there are ways to spend a dollar, but let’s consider the following ideas:
Reinvested tax savings is the gift that keeps on giving. I love using examples of the power of compounding returns to drive home a point. Let’s say we have a new self-employed business owner named Jesse. For this example, Jesse is 30 years old and plans to invest any additional tax savings into the stock market (the S&P 500 has yielded 10% over the last 30 years). Jesse decides to employ a tax accountant to develop a tax strategy which results in an additional $10k saved ever year until 60 years old. At the end of 30 years, Jesse will have an additional $1,809,434.25…. <author drops the mic and abruptly ends the article >
Oh, you don’t invest in the stock market? Tax plans can be customized for your own personal financial goals, and I’m sure most of our financial goals would be better off with an additional $1.8m in the bank; however, not every taxpayer chooses to spend or invest their money the same way. Whether you invest in stock, real estate or yourself and your business, a successful plan will keep you in mind first and foremost.
Are you preparing for a significant financial event? Paying taxes hurts, but there’s no pain quite like the unexpected tax bill. A successful tax plan should help to weed out any surprises. However, communication is key here. Plan to communicate with your tax professional on a regular basis. The more they know, the better chances they have to find opportunities.
“One must realize that all who have accumulated great fortunes first did a certain amount of dreaming, hoping, wishing, desiring and planning before they acquired money.” Napoleon Hill probably had his tax accountant on speed dial (that was a thing in 1937, right?) Regardless your political leanings or position on the new tax reform, one must recognize that we have been given a significant opportunity with tax reform. Contact your tax professional today to develop a plan to save more. Your future self will thank you.