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There’s an adage about how failure to plan means that you are planning to fail. For millions of people, this certainly applies to tax planning. Failing to properly plan can result in paying more taxes than you could have, or even missing out on crucial ways to build wealth.

So why is tax planning so important?

Table of Contents

What is Tax Planning?

Tax planning is when you consult with a tax professional to devise plans for managing your money with respect to tax obligations. These plans are often short-term, for immediate usage or a year-long strategy to incorporate over the ensuing tax year. 

Many individuals and business owners make tax planning appointments once or twice a year for advice on navigating federal, state, and local tax law changes then executing the tax professional’s plan.

Types of Tax Planning Services

Tax planning is when you consult with a tax professional to devise plans for managing your money with respect to tax obligations. These plans are often short-term, for immediate usage or a year-long strategy to incorporate over the ensuing tax year. 

Many individuals and business owners make tax planning appointments once or twice a year for advice on navigating federal, state, and local tax law changes then executing the tax professional’s plan.

Inheritance Tax Planning

While inheritances are generally tax-free at the federal level, there are some exceptions such as the inherited IRA. Depending on the beneficiary’s relationship to the decedent (deceased), inheriting an IRA will have different tax effects. 401(k) plans that the decedent leaves to a beneficiary also have tax consequences that are not present with non-retirement assets like real estate, cash, and personal property.

Inheritance tax planning helps the beneficiary navigate the tax laws surrounding inheritances, including what is allocated to the beneficiaries versus the decedent’s estate, to avoid costly mistakes at tax-filing time.

Additionally, tax planning is important while the decedent is still alive so they can determine how they would like to divide their estate and an optimal tax savings strategy for their beneficiaries and themselves while still living.

Retirement Tax Planning

Planning for retirement is often an overwhelming prospect. There are worries about having enough assets saved for retirement, with only 56% of American workers enrolled in workplace retirement plans while 15% have no retirement savings at all. In addition to these harsh financial realities, there are also tax aspects to contend with.

Depending on the options available based on whether the workplace offers a retirement plan, or you must plan one yourself as an employee or a business owner, it can be hard to determine which type of plan is best from a taxation standpoint. Many states have a matching principle with federal tax laws for how retirement plan contributions and distributions are treated, but plenty have their own state tax laws that may or may not benefit the taxpayer.

Retirement tax planning strategies maximizing tax savings for your current financial situation and what you reasonably expect your retirement years to look like, based on projected income in retirement and where you would live.

Business Tax Planning

Business owners often must factor tax provisions into starting up, winding down, expansion, transferring ownership, relocating, and day-to-day operations. In addition to federal, state, and local tax law considerations, business owners may be unsure which tax benefits are available to them based on parameters like size and industry. Properly planning for these aspects can save business owners vast amounts of money, as well as improve their recordkeeping systems for particularly valuable tax credits.

Business tax planning focuses on strategizing the most advantageous paths for the owner at various stages of the company’s growth, such as buying equipment and hiring employees or selling the business to an interested party.

Capital Gains Tax Planning

When an asset like a stock is sold for more money than what was initially paid, it results in capital gain income. A novice investor who does not have much money in the market, or is tied up in other assets like real estate and valuable collectibles, may not think about capital gains too much and simply pay the tax as it’s due.

Taxpayers with substantial holdings often need additional tax planning strategy sessions for planning their capital gain–or loss–timing. An asset that has significantly appreciated in value can provide wealth, but properly planning for the tax consequences of cashing it out can ensure you get to keep more of the wealth.

High Income Individuals Tax Planning

High-income individuals inherently have additional tax compliance measures to contend with every year, as they are eligible for fewer personal income tax benefits but are often faced with additional taxes (such as alternative minimum tax). Additionally, high-income taxpayers are more likely to be audited by the IRS.

Tax planning for high-income individuals encompasses staying compliant with relevant tax laws, additional income, and asset reporting mandates, and tax reduction plans for incoming tax years while minimizing audit risks.

Strategies of Tax Planning

While the above areas are common reasons why a taxpayer seeks a tax planning advisor, what is the actual strategy being implemented?

Every taxpayer is unique and requires tailored tax savings strategies according to their situation. However, the following are common strategies that fulfill the purpose of tax planning advisory.

Reduction of Taxable Income

One of the primary purposes of tax planning is to mitigate one’s tax liability. Reducing taxable income, whether it is the result of compensation or inheritance, varies by the tax year and often requires advance planning to time-specific transactions, or take advantage of certain tax benefits. 

Application of Tax Deductions

Tax deductions reduce one’s taxable income. They are available at both the business and personal levels, and state tax laws generally follow the federal matching principle but some states have specific items they disallow while granting deductions for items that are nondeductible at the federal level.

Properly planning for tax deductions can help you determine which items are eligible and whether the same items can be used for other tax benefits. This approach helps to discern which one is more advantageous.

Utilization of Tax Credits

Tax credits are a dollar-for-dollar reduction of your tax bill, which often makes them more beneficial than tax deductions. However, eligibility for tax credits depends on several factors, and whether the credit is refundable or non-refundable.

Since many nonrefundable tax credits have carryovers for future tax years, tax planning for tax credits can save thousands of dollars once eligible items and good timing have been determined.

Restructuring Business Entity

Of the many tax-related considerations that must be made when starting a new business, choosing the right entity is crucial for tax and legal purposes.

Planning for the wrong entity can result in costly mistakes and harsh tax compliance burdens. When a tax planning advisor helps a business owner choose the right entity, it is chosen for the taxpayer’s unique operational needs and industry. Restructuring into a new business entity may also be considered as the company matures, and the old entity is no longer advantageous.

Payroll Tax Planning Strategies

Hiring employees is the stage when operations begin to become complicated for business owners, as there are now payroll tax responsibilities separate from income and business taxes.

There are provisions with payroll tax administration that often need to be planned by the year, or fiscal quarter in addition to federal, state, and local payroll tax benefits that may only be available for a limited time (such as the Employer Retention Credit related to the COVID-19 pandemic).

Employee Benefits Tax Planning Strategies

Organizations that offer their employees retirement plans and other employee benefits such as transit passes, childcare benefits, and reimbursement plans often have complex tax provisions to navigate regarding these programs. Proper tax planning for employee benefits programs ensures that the organization stays compliant with recordkeeping requirements for these programs, and also takes advantage of relevant credits and deductions for offering them.

Consequences of Failing to Tax Plan

The unexpected often happens in business and in life. Not every event, economic and otherwise, can always be planned for.

But for the foreseeable events and reasonable expectations when it comes to business and personal taxes, failing to plan for likely outcomes can cause incredibly expensive headaches.

It can also be disappointing to discover that you could have saved thousands of dollars by timing that stock sale for just three days later, long enough to meet the long-term threshold instead of the short-term. Or that you chose an S corporation over a single-member LLC and must bear more expensive compliance burdens, just to find that the city you live in is inhospitable to this entity.

Taking the time to consult with a tax planning professional at Tax Shark who analyzes the parameters of your situation can give you peace of mind, along with a detailed action plan for the transactions you reasonably expect to see, or know are up ahead.