What is Tax Planning?
Tax Planning is an art of arranging your financial affairs and defers taxes through taking advantage of beneficial tax-law provisions, increasing and accelerating tax deductions, and tax credits. It is maximizing the use of all applicable tax breaks available under the Internal Revenue Code. Therefore, tax planning helps you determine what you should do today, when you should do it and how you should do it. This may result in substantial tax savings. Usually the tax savings are more than one tax year.
There are several ways of Tax Planning:
- Short-term Planning: This is planning executed at the end of the income year to reduce taxable income in a legal way. Suppose, at the end of the year, you discover that your taxes have been too high in comparison with last year, you can make proper arrangements to get them reduced before the end of the year through tax planning. It does not involve a long-term commitment, but results in substantial tax savings.
- Long-term Planning: A planning done at the beginning of the income year to be followed for several years. This planning will not pay off immediately, but is likely to help in the long run.
- Permissive tax Planning. This planning takes advantage of different incentives and tax deductions.
- Purposive Tax Planning. This is planning with a specific purpose to ensure availability of maximum benefits through a correct selection of investments, or replacement of assets, varying residential status and diversifying business activities and income.
Is there a difference between Tax Preparation and Tax Planning?
Yes, with tax preparation you are looking at history. This is a reactive approach. Once December 31st of each year is over you can’t change history. Anything you could have taken advantage of to reduce your tax liability is over. All you can do is sit and wait for all your tax documents (i.e. Form 1099s, and W2s) to arrive in the mail and then hand them over to your Tax Preparer by April 15th or even do it yourself and probably receive a refund or pay any tax due. Another option would be to file an Extension if your information is not ready.
With Tax Planning you are taking a proactive approach. The focus is on today and the future. For example, receiving a huge refund year after year is a sign of no tax planning. It is not a savings account. Ask yourself, is it earning interest? As a taxpayer you could have used that money throughout the year to feed your kids or even invest it in your retirement plan, college education or even start a side business.
Is Tax planning for the wealthy?
NO. Tax planning is often looked at as a benefit only to wealthy taxpayers, but the truth is even a lower income taxpayer can benefit from tax planning because it’s not how much you make…it’s how much you keep. Those who work as independent contractors will discover that with tax planning, it helps them stay ahead and develop a financially sound practice of keeping track of their earnings and paying the quarterly estimated tax payments that way they are not caught by surprise come tax filing time. This also helps them to avoid the underpayment penalty of estimated taxes. As a taxpayer you want to avoid unnecessary underpayment or overpayment of tax.
Investing in Tax Planning in order to avoid or put off paying taxes until a later date gives you, the taxpayer, discretionary money to spend or invest. A tax plan allows you to take as many tax breaks as possible and works within the tax law to increase allowable deductions and credits. If you find yourself at tax filing time thinking that you should have itemized more deductions or should have put off a large transaction, you will benefit from tax planning.
Tax planning equals fewer surprises come tax preparation time.
Who needs Tax planning?
(1) Business owners, (2) Real estate investors, (3) long term investors.
- Business Owners: As a business owner you can implement tax planning through entity selection. Meaning, how you registered your business as a legal entity can have a huge impact on your taxes. As a business owner you can operate your business as either a Sole proprietor, Corporation, or Limited Liability Company. Knowing the pros and cons of each entity designation is the key to optimizing your tax strategy and maximizing your profits especially now in light of the new tax laws.
- Real estate investors: Real estate can be your primary or secondary source of income. It all depends on how you hold it and make it work to your advantage.
- Long term investors: It all depends on whether you choose tax advantaged investments and how you structure your portfolio.
Talk to a Tax Planning Strategist to learn more about tax-reducing strategies and keep more of what you have earned.
We take time to plan our vacations and holiday parties. Let’s take time to plan our finances. When you plan you are better prepared.