Here's How Strategic Tax Planning Reduces Stress and Increases Wealth
For many, Tax Day can be one of great distress and anxiety. Whether it is remembering an entire years’ worth of financial transactions, tracking down receipts, or simply the fear of having to write a big check to the IRS, many taxpayers experience a sense of dread as the April 15 deadline approaches.
The apprehension commonly associated with tax season, however, can be significantly reduced with effective tax planning throughout the year. By adopting a proactive approach, which includes regular reviews and adjustments, the Tax Day deadline becomes less stressful and more routine.
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While often used interchangeably, tax preparation and tax planning are distinctly different activities—each playing an integral role in a well-designed financial plan.
Tax preparation is the process of compiling financial records and receipts, completing the appropriate tax return forms and schedules, and submitting that information to the IRS on time and in accordance with the U.S. Tax Code. It is a retrospective activity—focusing on accurately reporting every financial transaction that occurred within the year—with the goal of simply being compliant with the law.
The tax preparation process is often reactive rather than proactive, concerning the financial decisions you have already made. Preparing and filing tax returns annually is critical to avoid fines and penalties, but it typically does not involve looking ahead to future tax years.
In contrast, tax planning is a proactive and forward-looking process that goes beyond simply fulfilling legal obligations. It involves analyzing one's financial situation with the goal of achieving tax efficiency, structuring finances in a way that minimizes tax liability permanently. This process is particularly important for high income earners who may see a larger share of their income subject to taxation each year and have more to gain in potential tax savings.
Effective tax planning considers multiple aspects of your financial picture, such as the timing of income and the form in which it is received, the size and timing of purchases, and the location of assets among various account types and legal structures. This approach requires an understanding of various tax rules and how they interact with each other, as well as an appreciation for how financial decisions made today can impact your tax situation in the future.
In fact, high income earners and high net worth individuals should ideally be in the habit of planning several years in advance, since many tax minimization strategies (e.g., investments, retirement contributions, and estate planning) require a long-term perspective to be effective. Thus, anyone falling into one or both of those categories ought to seek the guidance of an accountant or other qualified tax professional who can offer personalized advice that aligns with their long-term financial objectives.
That said, not all accountants practice tax planning. In fact, many professional tax preparers’ services focus solely on the past, ensuring that what you've already done is accurately reported and compliant with current tax laws. However, this approach likely overlooks opportunities that will positively impact your tax bill in future years. An accountant practicing tax planning can review past transactions and offer guidance on the ways that upcoming changes in tax laws, income, expenses, and investments will affect your personal financial situation.
And while it is possible to do it yourself, for those with complex tax situations, it can be tough to stay updated on the complexities of the tax code and its constant changes. Further, interpreting and applying the various tax laws may cause individuals to overlook key deductions or credits, misinterpret regulations, or make errors in reporting, which can all be costly.
Since the goal of tax planning is to reduce the stress associated with Tax Day, as well as limit the size of the check being written each year, the distinction between tax preparation and tax planning is not just a matter of semantics but represents a potential shift in overall financial well-being. By opting for a more proactive and progressive approach to preparing and filing a tax return each year, high income earners and high net worth individuals can potentially position themselves to reap substantial long-term rewards.
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Malcolm Ethridge, CFP® is an Executive Vice President and fiduciary Financial Advisor with CIC Wealth Management, based in the Washington, DC area. He is also the Managing Partner of Capital Area Tax Consultants.
Malcolm’s areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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Disclosures:
CIC Wealth, LLC does not provide legal or tax advice. Be sure to consult with your tax and legal advisors before taking any action that could have tax consequences.
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