The Difference Between Tax Planning and Tax Preparation

Time to read: 5 Minutes

April 15^th is looming closer and closer, which can only mean one thing: tax season is upon us.

Many people only think about taxes this time each year. They see them as a necessary, but not very welcome, chore where their only goal is to accurately file their returns without paying any more than necessary.

Others, however, have a much more proactive approach. Rather than only thinking about their taxes between January 1^st and April 15^th each year, they consider it to be a vital part of their financial planning strategies and are always looking for ways to minimize their liability.

Keep reading to learn more about the difference between tax preparation and tax planning, what financial professionals can help you with each practice, and strategies for reducing your taxes throughout the course of your life.

Tax Preparation.

When people talk about tax preparation, they’re referring to accurately preparing and filing their taxes with the goal of paying the least amount they can in any given year.

When somebody hires an accountant or other financial professional to file their taxes, they aren’t looking for long-term tax advice or to change how their money is structured. Instead, they’re looking to maximize deductions as much as legally possible while filing returns correctly, accurately, and in a timely manner.

Tax Planning.

Unlike tax preparation, which looks at the previous year with the goal of maximizing deductions to decrease the immediate tax burden, tax planning looks to lower your overall lifetime tax bill as much as legally possible.

The goal of tax planning is to structure finances, including investments, savings, income, milestone planning, and assets, in a way that reduces the tax burden throughout the course of someone’s entire life. This may mean that somebody ends up paying a little more in any given tax year, but will pay less overall over the next 10, 20, or even 30 years.

What Financial Professionals to Work With.

For people not seeing a financial advisor, an accountant or CPA may assist with tax preparation. Individuals with fairly straightforward taxes may also choose to prepare and file their taxes themselves or using online tools.

For tax planning, however, a financial advisor or wealth management firm will work with a client on ways to reduce their lifetime tax burden as part of their broader financial plan. Just as they create a road map to achieve certain goals or reach specific milestones, a financial planner is implementing strategies that will reduce the tax burden of their clients now and in the future.

Strategies for Reducing Lifetime Taxes.

There are many strategies that can be used to reduce lifetime taxes, but some will not be applicable to every individual’s specific circumstances or situation.

One of these is deferred compensation. Many high-income earners, especially those who live below their means and thoroughly plan for upcoming milestones, find that they’re making more money than they need to cover their living expenses as well as their savings and investment goals. While this sounds like a great problem to have, it does come with a higher tax bill, and sometimes a higher tax bracket. If their employer offers deferred compensation, we often find that deferring some of their compensation for retirement allows them to reduce their present income (and tax burden) and instead receive the money later, when they’re likely falling into a lower tax bracket.

Other tax planning strategies, like investment strategies, apply to anybody with a large investment portfolio. Strategies like tax-loss harvesting help offset capital gains by selling investments at a loss, while assets held longer than a year are taxed at a lower rate than those that are sold more quickly.

When many of us think about reducing taxes, we aren’t only thinking about ourselves. We’re thinking about estate taxes on any inheritance being left to future generations. By implementing strategies like lifetime gifting, utilizing tools like life insurance, and more, many retirees are able to maximize the impact of their estate without incurring additional estate taxes. In fact, sometimes this restructuring actually reduces the amount of estate taxes their loved ones will need to pay.

In the video below, Senior Financial Advisor and CFP® Jordan Bradford shares more about the difference between tax planning and tax preparation.

To learn more about what strategies may help to reduce your lifetime tax burden, contact our team today!