I am weird! There is just no way I can deny it. How am I weird? I love talking with people about their taxes! Now I know what you’re thinking. Who in their right mind likes talking about taxes? Me, of course, so if you are looking for some exciting conversations at your next dinner party you need to give me a call.
When I talk about taxes with people, I’ve found people usually express two thoughts. These thoughts usually look something like, “I don’t mind paying taxes, but I don’t want to pay more than I have to” and “I think I pay too much.”
The sad truth is these people usually are paying too much! Most Americans, particularly business owners, pay more in taxes than they are legally required to pay. A 2018 survey completed by Clutch, a company focused on helping you find the right business for providing you with services you need, found that nearly 30% of businesses feel they are paying more in taxes than they are legally required to pay.
In my experience the reality is that closer to 70% of businesses and business owners are likely paying more in taxes than legally required. I’ve also noticed this staggering statistic holds true for companies that currently have CPAs or other tax professionals filing their taxes. The other sad reality is they often go for years, often even decades, paying higher taxes than necessary without reducing their tax liability closer to what it should be.
What can these businesses and business owners do to reduce their tax liabilities? The answer is getting a professional to complete a thorough tax plan, more commonly called a comprehensive tax plan.
What is a thorough/comprehensive tax plan?
The term “tax planning” is heavily used but highly misunderstood. That is largely because of the significant difference between basic tax planning and comprehensive tax planning. When most people think of tax planning, they think of basic tax planning, which looks something like one of the following:
- What will my taxes look like if I…?
- How many dependents should I claim on my W4?
- How will my taxes change with this new tax law?
- I can save money on taxes by doing an IRA/401(k), right?
While it’s true all these questions fall into tax planning, everyone of them falls short of comprehensive tax planning. Comprehensive tax planning is an in-depth analysis of a financial situation, strategy, or plan from a tax perspective, with the purpose of finding the best elements to pull together into the most tax-efficient possibilities. It looks at multiple elements individually and comprehensively to analyze how the independently and unitedly impact your tax liability. This means a comprehensive tax plan looks a little more like this:
- If we do this, we will have these results. This result causes the tax liability to do this. This other result causes the tax liability to do that. Together they cause this cumulative effect. (This usually has more than two variables, but you get the picture!)
- We want to do A, B, C, and D. A causes the tax liability to do V. B causes the tax liability to do W. C causes the liability to do X. D causes the liability to do Y. Together they create Z.
- We have these options. Option A creates tax liability outcome A. Option B creates tax liability outcome B. Option C, etc. What has the best result?
- Some combination of the three options above
As you can see, comprehensive tax planning can get very deep fast.
What is the difference between financial planning and tax planning?
Tax planning and financial planning are very closely linked. A tax plan that fails to consider your financial goals is not a very good one, while a financial plan that fails to consider tax consequences is sure to disappoint you. That does not mean, however, that they are the same thing.
The purpose of tax planning is to legally reduce and avoid taxes. The purpose of financial planning, on the other hand, is to help you meet short-term or long-term financial goals. While a good tax plan considers multiple elements at the same time, a good financial plan considers multiple financial goals (often including both short-term and long-term goals) at the same time.
While tax planning and financial planning are closely linked, they are two separate areas of expertise. The best financial planners have a good understanding of tax implications, but don’t have the expertise to provide comprehensive tax planning. At the same time, the best tax strategists have a good understanding of how your financial goals fit into the tax plans they bring you, but they do not have the expertise to provide you with a comprehensive financial plan.
Often your financial goals can compete with the most tax-efficient strategies. If you decide to get both a comprehensive tax plan and a comprehensive financial plan, you should expect that you will find some of the financial strategies provided to you conflict with some of the tax strategies provided to you, and vice versa. This is actually a good thing because it gives you a complete set of options with the best tools for selecting the ones that fits your current needs and desires.
How does a comprehensive tax plan help businesses and business owners?
As mentioned earlier, the purpose of a tax plan is to provide you with options for reducing your tax liability by helping you legally reduce or avoid taxes. The IRS tax code is currently a few thousand pages long. (An exact figure is hard to give because there are several obsolete pages and skipped pages in the current code.) In addition to the pages of the code itself, there are over 70,000 pages of related documents that help provide interpretation, legal understanding, and application for correct tax compliance.
These multitude of pages provide tax payers with several possibilities when preparing taxes. These include different methods of accounting for the same activity, different forms of activity that can legally reduce your taxable income, different entity structures that provide unique and often complex alternatives for taxation, and tax loopholes that federal courts have upheld as legal. The code provides some alternatives for some types of business, some professions, and even some income levels, that are not available to others. At the same time, new tax law comes out on a regular basis, eliminating existing strategies, altering the benefits of other strategies, and creating entirely new strategies.
The purpose of a comprehensive tax plan is to evaluate the multitude of options available in the code in order to find the ones available for your business now. The professional preparing the tax plan uses their knowledge and experience with the tax code to bring options to you instead of leaving you to find them yourself. A well-prepared tax plan may at times provide you with a couple alternatives for handling the same activity, outlining the consequences of both so you can select the best one for your needs. Ultimately the goal is to give you the tools you need to get you into a better tax position than you were when you started.
Isn’t my current CPA/tax professional handling tax planning for me?
Most people believe their tax professionals or CPAs are doing their tax planning for them when they hire them to file their taxes on a yearly basis. Others have hired CPAs or accountants to meet their accounting needs and believe these professionals are doing the work for them. I unfortunately have found this is true at the basic level, but rarely true at the comprehensive level.
This creates a significant problem. Many businesses and business owners are lured into a false sense of belief that they are paying the least amount in taxes possible when they are not. That is why I see closer to 70% of businesses and business owners I work worth overpaying on taxes instead of the 30% that believe they are.
Does this mean your current CPA, tax professional, or accountant isn’t doing a good job for you? Absolutely not. Most CPAs, tax professionals, and accountants are very good at what they do, and most are doing more for you than what you’re paying them to do. The problem is you simply aren’t paying them for comprehensive tax planning, which is an entirely separate engagement.
When you consider the size of the tax code and the related material, it’s easy to realize that tax planning for you takes a significant amount of research and time and/or familiarity with your circumstances and the available strategies for you on the part of the tax strategist preparing your strategies. Due to its nature, tax planning also comes with unique liabilities. It’s unreasonable to expect the CPA or tax professional preparing your tax return or the accountant meeting your accounting needs to do more than basic tax planning on top of what you are currently getting, unless you have hired them to do both and are paying them the worth of both.
When should I seek a tax plan?
There are three questions to consider when considering getting a tax plan. First, is it better to get it at the beginning of the year or the end of the year? Second, how early in the life of your business should you get a tax plan? Third, do you need to consider getting another tax plan if you’ve had one in the past?
The answer to what part of the year you should get a tax plan completed is now. It doesn’t matter what part of the year it is. Get the tax plan completed as soon as possible. This is because, no matter what time of year it is, there are strategies available now.
Some tax strategies work best if they are in effect throughout the year. As the year moves on, you won’t gain as much in the current year by using them. For this reason it’s always best to try earlier in the current year if possible. You will still benefit in future years in most cases, so a tax plan at the end of the year is still effective for these.
There are other strategies, however, that can be effective even after the year ends. Retirement savings, for example, can be donated after the end of the year and still have an impact on your taxes. For this reason you should never put off getting a tax plan just because it is late in the year. There are likely still options that can save you significantly on taxes if done later in the year.
The second question has a slightly more complicated answer. It depends. Tax planning is obviously more effective as strategies have a chance to impact more of your income. For that reason earlier in the life of the company is an excellent choice. At the same time, you have more tax strategies available to you as your company grows, making a strong argument for delaying a little while. The decision is ultimately yours, and you will need to consider the pros and cons of the timing of your first tax plan before deciding. My general rule of thumb is that it never hurts to reach out and find out if you’re at a point you can benefit from it.
Finally, you should never consider one tax plan the final tax plan. Tax laws are constantly changing, just like you and your company. As things change your tax needs change. You should consider regularly reviewing your tax situation with your tax strategist to determine if the time has come for an updated set of strategies for you.
If you have not completed a formal tax plan, chances are you are paying too much in taxes. It’s not the fault of your CPA, your tax professional, or your accountant. It’s not even your fault, but it is your problem and your loss. If you’re like my average client, that means you are paying $26,515 more in taxes per year than you are legally required to pay. Imagine what you can do with an extra $26,515 dollars! Take the time to find a good tax strategist that can help you save money on your taxes.