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Just what is Tax Planning?

Just what is Tax Planning?

May 24, 2023

If you're a longtime reader of my articles, you've heard me talk a lot about financial planning, tax planning and that financial planning should include tax planning.  However, very often it doesn't because most financial advisors can't, won't or are not allowed to talk about tax planning.

But just what is tax planning? I consider tax planning to be a proactive approach to legally minimizing the amount of tax that you pay now and into the future.

You might be thinking to yourself that if you pay someone to do your tax return, they must be doing tax planning. Correct? 

The answer is probably no.  That is more likely tax compliance.  You are reporting to the government what happened last year and capturing income and deductions to report and minimize taxes owed for what happened last year.  Basically, it’s a reconciliation of what happened in your tax financial life last year.

Tax planning is a forward-looking process.  It may be looking to next year, 5 years from now or even decades out into the future to make choices now to minimize the amount of tax you might be paying over your lifetime.

There can be many forms but here's a couple simple examples.

I recently had a call with a new business owner of an LLC. We covered a wide variety of deduction methods (which reduce tax) and we talked about doing a change in the way that their tax return was filed that had the potential to save a significant amount of tax in this year and future years.   

If you're a single member LLC owner with a profitable business, and you want to do an S corporation tax election, you've probably heard of this. There is a related article in my Blog posts.

When we were nearing the end of our meeting, this person asked me if we could schedule a call to talk strategic tax planning.   I reminded this person that our call had just discussed a methodology that would very likely save tens of thousands of dollars over this person’s working career, money that could be redeployed into growing their wealth. 

In their mind tax planning was something much more complex.  Sometimes it is, but it doesn’t have to be.

The LLC taxed as an S Corporation is everyday tax planning for me, but I hadn’t thought that to others it might not be and so that was a key reason behind this article trying to give examples of real-life tax planning as one aspect of growing your wealth by keeping more of your resources in your possession through paying less tax legally.

Another common example, one that often involves financial planners not thinking or caring about the tax consequences of their actions is when you retire, and you look at doing something with your 401K.

I regularly see tax clients come in with a shiny new IRA that their financial advisor set them up with when they retire and I ask them why they didn’t do a certain other method that could have saved them thousands of dollars of tax. 

Almost every time they tell me that their financial advisor isn’t allowed to give them tax advice so they didn’t do that step. Sometimes they even try to defend their decision but the reality is that their tax return will now have tax on it for years into the future that could have been avoided with proper tax planning.

Those are a couple of simple examples of tax planning.  Another overlooked one is simply not capturing all the tax deductions that you are allowed to claim because you don’t know what is allowed, or more commonly your recordkeeping system is not very good.   That alone causes people to overpay tax because they can’t document deductions that they could have taken and forget to put them on their tax return.

The information in this and other articles is intended to be educational in nature only.  Not tax, legal or investment guidance for you specifically.  Each person’s situation is unique and you must seek appropriate professional guidance that can address your unique situation.