What Is Tax Planning, and How Is It Different From Filing Your Return?

Ah yes, the sound of ruffling pages, crinkled receipts, clicks of a calculator, and finally the exhale of relief. All of that means only one thing - it’s tax season!

While you’re likely used to tax preparation, have you heard of tax planning? And no, they’re not the same thing.

Tax planning can significantly impact your financial plan and your wallet. And it’s not too late to tax plan for the 2023 tax year.

Ready to tackle your tax plan? Let’s dive in!

Key Takeaways

Tax planning is a multi-year process that serves your long-term financial goals.
Any solid financial plan should include some sort of tax planning.
A close, trusting relationship with your advisor can strengthen your tax plan.

What’s Tax Preparation?

Aside from being something we look forward to doing all year (or not), it’s the process of accounting for all of your financial matters within the tax year and providing the Internal Revenue Service (IRS) with the required tax information.

Typically, you might work with a Certified Public Accountant (CPA) during your tax preparation. Because let’s face it, taxes can be complicated!

Some planning is involved in the tax preparation process, but it’s mostly reactive rather than proactive. Essentially, preparation will focus on maximizing what you can based on what you’ve already done during the tax year. This includes making the most of the available deductions, tax credits, etc, etc., available.

The Low-Down On Tax Planning

On the other side of the coin, tax planning is the process of strategically thinking of ways to reduce your total tax liability.

Most tax plans are a multi-year strategy making them proactive rather than reactive. A tax plan focuses on the future rather than the present or past. Unlike preparation, a tax plan gives you the roadmap for what you should be doing moving forward, rather than making the most of what you have now.

Why Tax Plan?

Taxes are non-negotiable, so you may as well make the best of them!

Unless you’re a lawmaker, you don’t get a say in how much tax you owe to the IRS. A tax plan allows you to take control of your tax impact.

In addition to hopefully reducing your taxes, tax planning is another way for you to have a clearer bird's eye view of your finances. Having a handle on your taxes and finances, in general, can give you flexibility with your income plan, savings plans, and help keep your investments running smoothly.

A well-thought-out tax plan can also potentially save you from making expensive mistakes like missing required minimum distribution requirements (RMDs) or going through the year with improper tax withholding. This could not only leave you with a large tax bill but also additional penalties depending on the infraction.

What Your Tax Plan Needs to Consider

You might be thinking “This all sounds great, but where do I start”?.

Before diving into the thick it, ask yourself these questions:

Is your income higher or lower today than it will be in the future?
- Your answer can suggest which type of savings accounts are right for you. For example, if you think your income will drop significantly during retirement, it may behoove you to place your retirement savings in a tax-deferred account (like a Roth account). Why? If you’re in a lower tax bracket, your tax bill will also be lower.
When do you anticipate needing to access your money?
- For most retirement savings accounts you’re not allowed to withdraw funds without penalty until after the age of 59.5. If you’re planning to retire early, or are worried about not being able to access your money when you need it, it can impact what type of savings accounts you should utilize.
What does your ideal retirement lifestyle look like?
- Will you be moving to a new home, keeping a part-time job, watching your grandchildren full-time, or spending your days volunteering? All of these things have an effect on your retirement income plan and thus the best ways for you to save money effectively.

Tax Planning Strategies

We’ve compiled a snapshot of some tax planning strategies that may be helpful to you and separated them into three categories: tax bracket management, tax-savvy investments, and tax-friendly savings accounts.

Tax Bracket Management

Unsurprisingly your tax bracket has a large impact on your tax bill. These strategies can be used to potentially lower your taxable income and bracket.

Tax Credits: There are so many tax credits out there! They range from solar tax credits, electric vehicle credits, child tax credits, etc. Work with your financial team to make sure you’re taking advantage of the ones you qualify for.
Charitable Giving: There are no taxes on any capital gain if you donate cash or securities to charity. And, as an added bonus, it won’t be included in your taxable income. Just remember to be wary of the Gift Tax if you donate cash.

Tax Savvy Investments

You don’t have to be the Wolf of Wall Street to be a strategic investor! These strategies can help you make the most of your investment gains.

Asset Location: Each investment type has varying degrees of tax-efficiency. This strategy seeks to place your investment types (stocks, bonds, ETFs, mutual funds, etc.) in the investment account that offers the best tax treatment.
Long-term capital gains: You will be taxed at a lower rate if you sell assets that have long-term capital gains, aka investments you’ve held for at least a year. For most people, the long-term capital gains tax rate is lower than the ordinary income tax rate (how the IRS taxes short-term gains).
Tax Loss Harvesting: This is a strategy that includes selling certain investments at a loss to offset a current or future capital gain. This can be tricky to do, but if done properly can help you manage your tax bill when it comes to your investment profits.

Tax-Friendly Savings Accounts

During retirement, your income comes from many different sources that all have unique tax characteristics. Depending on your retirement savings plan and lifestyle plan, your tax plan could include any combination of pre or post-tax retirement savings accounts.

Pre-Tax Accounts: Examples of these accounts are 401ks and Traditional IRAs. They allow you to contribute pre-tax dollars that will grow tax-free until you make withdrawals. When withdrawals are made, all of your contributions and earned interest will be taxed as income.
Post-Tax Accounts: You may have heard these accounts described as “Roth”. They allow you to contribute after-tax dollars and let it grow tax-free. Since the money you contribute is post-tax, you don’t have to pay any taxes upon withdrawals.

Why Is This Important For Tax Planning? The ways in which you save money for retirement can affect your retirement income upon withdrawal. By thinking strategically about what your retirement income and lifestyle plan will look like, you and your financial team can decide which methods best serve your needs.

Ultimately, a solid tax plan will contain a mix of strategies that fit you and your financial goals. It’s an ongoing process, but when done well it will help you create a holistic financial plan that is aligned with your short and long-term goals.

Who You Can Turn To For Help

Tax planning requires a deeper connection between you and your financial professional. To create a plan that will last in the long run, you will need to establish trust and transparency in your advisor-client relationship.

Why? Because any good financial plan needs to be tied to your values and personal goals.

At AVID Planning we take great pride in creating a financial plan that gives purpose to your money. Our Purpose Driven Money System combined with a solid tax plan is a great way to set yourself up for financial success.

If you’re ready to take your finances to the next level, please reach out to us today.