Tax Planning vs. Tax Preparation
When people pay for a tax professional to help with their taxes, there are actually two separate services available – tax preparation and tax planning. Most people assume that if they pay for tax prep, the “planning” comes with it. But, that’s not always the case.
Tax preparation is pretty straightforward – making sure the numbers go into the correct spots on the tax return. It’s more complicated for some taxpayers than for others, so it often makes sense to pay a professional to help. But this process is done after the year is over, and the focus is on making sure the tax return is correct – there is very little that can be done during the preparation that will have a big impact on the amount of taxes someone pays.
Tax planning means different things to different people, so we’ll focus on what it means at Numberwise. Our Tax planning involves 3 components:
- Reviewing your tax situation during the year to determine if anything can be done to reduce your taxes.
- Calculating required tax payments you may owe, which would likely be due quarterly.
- And estimating future taxes.
Who needs tax planning? We highly recommend investing in tax planning services if you’re:
- A business owner
- An individual who earns a large amount of money outside of a W-2 from your job (i.e. from a side-gig, large investments, or a one-time capital gain)
Let’s face it, most people think this is the only reason to do tax planning. They hire a professional to get their tax bill lower. For a business owner, this might be calculating if a big purchase makes more sense this year or next year. It could be a discussion about the best type of retirement plan to set up for their business. Or it might be developing a strategy for the best way to structure the sale of their business.
The tax code is especially complicated for business owners, and the amount of tax you pay depends largely on the timing and nature of your income. So, any tax planning session should include a discussion on tax minimization. But that isn’t the only reason to invest in tax planning.
Paying Required Taxes
Taxpayers who only receive income from their paycheck usually don’t have to worry about paying their taxes throughout the year. Their estimated taxes are withheld from their paycheck. While they might receive a small refund or owe a small amount when they prepare their returns, this doesn’t really require planning (other than filling out the state and federal tax forms correctly when hired).
Business owners who do not receive a regular paycheck don’t have the benefit of those automatic tax withholdings. So, an important part of tax planning for business owners is calculating the amount and timing of their tax payments. Depending on the structure of the business, they might be in the form of quarterly tax payments or they might be withholdings from wages. Without this type of planning, the taxpayer could be subject to big penalties from the IRS. It might not result in lower taxes, but it definitely results in savings for the taxpayer.
Planning For Future Taxes
While it’s wonderful to save money, we believe the greatest benefit of tax planning is the peace of mind you’ll have knowing about future tax payments well in advance. The last thing you want is getting your tax return prepared in April and realizing you owe a large sum of money that you don’t have. Or worse – finding out in October that you owe a bunch of money that was due back in April – and now there are penalties and interest on top.
Maybe you sold a house and want to know how much to put aside for when your return is eventually filed. Or you are planning on selling your business and want to know how much of the potential sale you will be able to keep. Whether it is short-term or long-term, nobody likes a surprise tax bill – and planning can keep the surprises to a minimum.
The Bottom Line
Tax planning is a vital task for profitable businesses, but many business owners overlook it. Too many people pay for tax preparation and assume they are covered. But if all you pay for is preparation, you can’t (and shouldn’t) expect that the planning piece is getting done. At Numberwise, we believe that tax planning is a necessity. Be sure to reach out to your tax professional to make sure you are getting what you pay for – and paying for what you need.