Tax planning made easy

revised 12/17/2014

Shrinking your personal or business  tax bill may be easier than you realize.

Tax planning is the process of systematically looking for legal ways to reduce taxes that fit into your overall financial plan. Tax planning is quite different from tax return preparation since we actually create a tax saving strategy in advance rather than wait until tax filing time to look back at your records. Tax planning should be done well in advance of the tax return preparation and is typically uses multi-year strategies.

My own occupational specialty is actually referred to "compensation and benefits planning". I prefer to say "tax planning" but the fact is that most tax saving opportunities stem from planning of income and benefits. The basic tax planning approach is to make the "inflows" tax free and the "outflows" tax free or tax deductible. In the process of reducing taxes, we usually find that some of that savings is reallocated to building wealth.

How does the process work? You tell the tax planner your story - your sources of income, casual projections for the coming year, the trends in your business, etc. The tax planner asks questions and responds with ideas that have worked for others in similar situations. If any of these ideas catch your attention, you pursue the discussion to see how the proposal may fit into your financial plans.

How does it work out? In my experience, most people who go through the tax planning process spend a few hundred dollars on advice and save a few thousand dollars in taxes. Of course, every individual's finances are different so different results should be expected.

Avoid common tax errors

When it comes to taxes, most of us make errors. It's not our fault; the system is ridiculously complicated. Some errors are made when preparing the tax return. Others errors are made long before that time by not taking the steps that would have reduced taxes. Yet taken together, these two types of errors can add up to significant lost financial opportunity over a lifetime. This short list of the most common errors was distilled from several sources that report on the observations of financial advisers who review tax returns prepared by others.

Most common tax filing errors:

1) itemized deductions
2) rental property deductions
3) cost basis of investments

Tax advisers suggest that everyone should have their tax return reviewed by a person other than the person who prepared it. That review can be completed at any time, but it is clear that the sooner the better in terms of options that will be available if changes are justified. While most reviews result in either the discovery of an error / oversight OR an alternate possible approach to reporting the same transactions. Not all reviews result in a recommendation to amend the return; in fact this occurs in only a few returns where the change justifies the cost and risks of amending.

Look for tax saving opportunities

I publish a number of free online checklists designed to point out opportunities to save taxes (see the home page or the publications index). Each option that is possible has a unique cost and a benefit to be considered. An easy way to develop a list of tax planning possibilities is to schedule an individual tax planning review.

Recognize that tax return preparation is completely distinct from tax planning. Don't assume that a CPA or tax preparer is necessarily a good source of tax planning strategy simply because the topic may come up in conversation about your tax return. It pays to treat the two separately and seek out a tax planning professional.

Most common tax planning oversights:

1. Failing to utilize losses to reduce taxable income
2. Reacting to tax changes after the fact rather than anticipating and planning a strategy in advance
3. Not realizing the potential impact of tax planning
4. Lack of coordination between professional advisers