Few Americans enjoy filing their taxes, I’m sure. (Those that do probably work for H&R Block!) But for those looking to gain an edge and keep more of their own money each April, there’s one important distinction to keep in mind all through the year.
That key: knowing the different between “tax planning” and “tax preparation.”
Tax planning looks forward, seeking opportunities and strategies to reduce your tax liabilities in the future. In contrast, tax preparation requires looking in the rear-view mirror, and gathering and organizing your information from a past year, primarily for compliance with tax laws.
In practice, most people think they’re planning when they’re actually just preparing. Especially in early April, many Americans fixate on their taxes, trying to reduce the amount they’ll owe on the 15th. The problem with that approach is there aren’t many ways to significantly reduce taxes in a given year when you’re midway through the next. Once the tax horse is out of the proverbial barn, the best advice involves reminding taxpayers of deductions and credits they might otherwise forget.
However, any competent tax preparer or online tax-preparation software will optimize a taxpayer’s options, such as filing status, the use of standard versus itemized deducting, or the availability of credits based on dependents.
While the goal of tax preparation is to avoid leaving money on the table, the goal of tax planning is to have more money on the table in the first place. Americans would be far better off if they worked with a CFP® ahead of time to consider strategies they could use going forward, such as timing income and deductions across different tax years, choosing the best retirement plan options, or converting IRAs and 401(k)s into Roths – just as they make sure the i’s are dotted and the t’s crossed on their 1040 for last year.
As for other mistakes – like getting big refunds every year or confusing what is owed on April 15 with total tax liability – that’s an entirely different discussion.