Tax Prep. vs Tax Planning
To many, this may seem like a distinction without a difference or a trigger for mild nausea and severe eye-glazing! While both are as important as they are interrelated, they are rather distinct in practice. Here are the main differences:
Tax Preparation:
Backward-looking
Seasonal event (January-April)
Requires a CPA or tax preparer
Ensures compliance with federal and state law
Often focused on minimizing taxes in the current year (without a view toward the long run
Tax Planning:
Forward-looking
Year-round process
Requires advisor with a comprehensive view of your financial situation and your goals combined with knowledge of the tax system
Seeks to maximize your after-tax net worth over time, not just create short-term savings
So while tax preparation and compliance reside squarely in the domain of qualified CPAs, your wealth advisor or CFP may be in a better position to provide forward-looking tax planning and execution. In practice, having a strong working relationship between your financial advisor, your accountant, and your attorney is critical to keeping you compliant and ensuring the proper execution of your plan.
Tax Planner’s Toolbox
Because your financial planner has the most comprehensive view of your financial life (and its many intersections with your actual life), he/she is usually in the best place to coordinate and help you carry out a long-term plan to maximize your after-tax wealth.
These are the most often used tools of the trade:
Pre-tax vs tax-free retirement accounts (Roth vs. traditional savings)
Strategic Roth conversions
Tax loss/tax gain harvesting
Charitable giving through gifts of appreciated assets through Donor Advised Funds (DAFs) or Qualified Charitable Distributions from pre-tax retirement accounts,
Retirement drawdown strategies
Estate and legacy planning
Managing the tax implications of employer stock awards and options
Adjusting your plan to changes in tax policy
Modeling and managing your tax bracket over time
Who benefits most from tax planning?
Just about everyone stands to benefit from some basic tax planning, especially with regard to the location of retirement savings (e.g. Roth vs traditional) and managing the impact of capital gains. Of course, your level of income and net worth, and the complexity of your situation matter a great deal in determining which strategies are most viable and the size of their benefit.
In general, these individuals will benefit the most from ongoing tax planning:
Business owners: tend to have more variable income and some ability to control the form and timing of that income
High earners: fall into a higher tax bracket, therefore increasing the potential benefit (and the opportunity cost of forgoing) of various tax strategies
High net worth: have a greater percentage of income from investments compared to earned income
Retirees or near-retirees: you may not have considered yourself to be a high earner or wealthy throughout your career, but by the time most folks reach retirement, they need to have substantial savings and investments
Sudden wealth events: the sale of a business, an inheritance, or a windfall of some kind can have massive tax implications
Variable income: have the opportunity to take advantage of tax strategies that are most fruitful to low earners in down years (tax gain harvesting, Roth conversions) and maximize income deferral and offset strategies in up years.
