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What Is Tax Planning?

Taxes are a necessary part of everyone’s life. With proper planning, you can avoid mistakes and maybe even save money.

Taxes are a necessary and, often, stressful part of our lives. However, the whole process can be hard to understand, and you may even wonder if you’re doing it right. This is where tax planning comes in. Knowing what you need to do ahead of time allows you valuable peace of mind.

Tax planning is when you or a professional work to ensure you follow the laws, while also minimizing the amount you pay. It typically involves identifying deductions, timing income and expenses, as well as optimizing investment strategies (such as using a Roth IRA). 

Whether you’re running a business or an employee for a large corporation, tax planning is a smart practice. In this article, we’ll explain why it’s important, how it works, and what a professional can do for you. You’ll also learn how to find a qualified expert to help you out.

Why Tax Planning Is Important

Picture a scenario where you’ve started a small business, with which you’ve just started turning a profit. In this case, questions like “How do I pay the IRS?” or “How can I save money on taxes?” may come to mind. This is why planning ahead is so important. It helps you know what to do, avoid critical mistakes, and save money.

Optimizing your taxes, either by yourself or with an expert, provides several benefits. First, you can avoid paying too little and owing money to Internal Revenue Service (IRS). You’ll also be able to identify deductions to help you save more money when you file. Finally, you avoid a ton of undue stress.

Here’s a brief, but specific look at what you stand to gain by planning out your taxes:

  • You might pay less. Assessing your tax burden ahead of time can help you identify deductions that save you money.
  • Knowledge of and compliance with laws. Let’s face it, laws regarding taxes can be difficult to keep track of. Having a strategy in place can help you understand and follow local and federal regulations.
  • A clear picture of your financial situation. Tax planning lets you realistically know how much money you have to spend, save, and invest.
  • Less stress. Above all else, you’ll be able to worry less when you plan out your taxes.

How Tax Planning Works

How you prepare for taxes depends mainly on your financial situation, as well as the laws that apply to it. For instance, a business owner will pay differently than an employee would. Overall, the planning process includes several steps. Each will get you on track toward paying the right way and, potentially, saving money:

Understand Tax Laws and Evaluate Your Finances

The first step in the process is ensuring you understand both federal and state tax laws. This also goes hand-in-hand with your financial situation. So, it’s crucial that you take the time to assess your income and liabilities. 

Other details, such as whether you’re self-employed (or a business owner) or an employee, are key deciders in how you pay. As an example, if you’re an LLC owner, you must typically pay estimated taxes (a combo of self-employment and federal income) quarterly as well as file forms annually (the type depends on how you structure your business). However, if you’re simply an employee, your income will be automatically withheld, and you’ll receive a W-4 and W-2 form at the end of the year.

Once you have a clear picture of your finances, you’ll be able to determine which rules and regulations you need to follow.

Identify Tax Breaks

A key part of the process is figuring out how you can save as much money as possible. Often, you can do so by utilizing deductions, which cut down your taxable income. Common ones include:

  • Business expenses. Costs associated with your small business, such as mileage or a home office, can be used as deductions to save you money.
  • Itemized. This refers to specific types of expenses, like real estate, philanthropy, and even gambling loss.
  • Education. Costs that relate to school and education, such as tuition, can be used as a deduction.
  • Health care. Paying for medical or dental services can allow you yet another deduction method.
  • Investment expenses. You’re able to use certain expenses that relate to investing, such as the costs to sell a home or losses, as a deduction.

Another way you can save money is by using tax credits. These lessen how much you owe the IRS. Having dependents in the household, driving a clean vehicle, and being a homeowner are all typical credits you can use. 

Time Income

When you receive income has implications on your taxes. Making more money can put you in a higher bracket, requiring you to pay more to the government. Luckily, you can time certain types of income to ensure you’re paying optimally. Examples of these sources are:

  • Self-employment income
  • Bonuses
  • Retirement
  • Government securities, such as the U.S. Treasury Bill

Investment Considerations

When you invest your money, taxes are an important factor. For instance, if you make a profit investing with a regular brokerage account, you’ll be subject to capital gains tax. However, if you do the same in a Roth IRA, you won’t owe anything. Before you invest, you’ll want to figure out which types of accounts and securities are best to minimize what you owe and maximize your returns.

Maintain Compliance by Keeping Records

After you have a plan in place, you’ll want to maintain complete and accurate records. This way, if the IRS comes knocking for an audit, you’ll be prepared. Plus, you’ll just be more organized in case you want to look back for yourself or meet with a professional.

Role of a Tax Professional

Depending on how complicated your finances are, it may be beneficial to hire an expert to help with your taxes. Professionals will work with you to create a plan which saves you money and keeps you in the IRS’s good graces. However, there are several types of pros to choose from. Here’s a quick breakdown of each one:

  • Certified public accountants (CPAs). CPAs are state-licensed professionals that provide accounting services, such as tax preparation and auditing, for their clients.
  • Tax attorneys. These are professionals who’ve passed the American Bar Association’s (ABA) exam to become an attorney and who offer tax preparing or planning services.
  • Enrolled agents (EAs). An EA has received a license from the IRS to advise and represent clients regarding their taxes.
  • Non-credentialed tax preparers. These are individuals who offer tax-preparing services without any formal credentials or licenses. However, in ten states, the IRS requires non-credentialed preparers to participate in specific courses relating to the subject.

Each of the above can help in some way with tax preparation and planning. However, costs and verified expertise can vary. As a rule of thumb, the more credentials one has, the more expensive they’ll be.

A normal financial advisor, such as a certified financial planner (CFP), may also be able to assist with tax-related issues. At the very least, they may be able to take what another expert helps you with and implement it into your overall strategy. To find a vetted financial advisor, you can use this free tool, which matches you with up to three near you.

How Much a Tax Expert Costs

The cost to hire a tax planner will vary depending on who you select and how they structure fees. Most will either charge you a flat or hourly (anywhere from $75 to $400 per hour) fee. If you work with a financial advisor, they may charge you a percentage of your assets under management (AUM), which is typically 1% (but it may go up or down depending on how much you have).

In terms of tax planning, how much you pay can also depend on the complexity of your situation. If all you need to do is file a personal return, you shouldn’t expect an exorbitant rate. However, if you’re a business owner with several sources of income, you could be paying a lot more.

Frequently Asked Questions

How much should I pay someone to help with my taxes?

This depends on what you’re trying to accomplish. If you only have one source of income, it’ll cost much less to meet with someone. But for those with multiple income streams, such as real estate or a business, you can expect to pay much more.

What’s the difference between tax planning and preparation?

Tax planning generally refers to creating a holistic strategy for you to follow based on your current financial situation. Preparation, on the other hand, involves getting IRS forms ready for filing.

Will tax planning save me money?

You’ll likely save money by putting together a tax plan. This is because you’ll have taken the time to identify deductions and credits that will lessen what you pay. You may also be able to time income so that you remain in a lower bracket for the time being.

Is it worth hiring a tax planner?

In most cases, it’s worth hiring someone to help out. Without one, you may be leaving money on the table in terms of finding deductions and credits for you to pay less. They’ll also be able to work with you to ensure you’re staying compliant with ever-changing rules and regulations.