What is the difference between tax planning and tax preparation? It really is about timing. Tax preparation is the result of a combination of a year’s work and planning or the lack of planning down during the year. In short, planning is what you do all year and preparation is the mea culpa where taxpayers try to hold on to as much of their hard-earned money as they can.
Effective tax planning can be broken down into two major areas, decisions with tax implications and the recordkeeping to preserve those deductions. Audits and problems involving the IRS generally result from failed planning and the inability to prove claimed expenses.
The solution requires a little time spent on a consistent basis and is facilitated by working with a professional in that capacity. The simplest starting point is basic recordkeeping. Records can be kept in a simple ledger, a complex computer system or anything in between. The method of keeping records is not nearly as important as that it be done consistently.
In performing this recordkeeping, keeping all records in one central location facilitates locating information at tax preparation time or other times when needed. Receipts for expenses are especially critical. There have been many taxpayers loose valuable deductions at audit because they could not prove the expense at audit. I suggest that receipts be kept in folders using a logical organization scheme such as chronologically or by vendor.
These records include all evidence of transactions including receipts, canceled checks, copies of checks deposited, credit card statements, and other records. These should be kept for at least three years. I recommend keeping them five years. In the case of property records, both real and personal, these records must be kept from the time of acquisition until five years after the property’s final disposition.
The other part of tax planning requires the help of a professional well-versed in tax law. This part of tax planning involves business decisions. These decisions range from the simple purchase of a replacement computer to opening new offices or buying expensive new equipment. Of course, a business owner will not make such important decisions based solely on the tax ramifications, but such considerations are very important.
As an example, consider the manufacturing plant that must buy a new piece of equipment for the plant. Further, consider the decision to buy will be made in December. The year has been reasonably profitable, but it hasn’t been the best year. Should the business owner buy the equipment now or wait until the following year? Depending on the cost, it may be completely deducted in one year or over several years. In making this decision, the tax question becomes one of need. When will the deduction help the business the most, in the current year or the next year?
This is where the tax advisor earns his pay. Working close with the business owner, a competent tax advisor will help the business owner make decisions that have the greatest possible chance of making profitable decisions that minimize tax liability and are completely defensible in the event of IRS review.
Tax planning is a year long process that, done correctly, will keep much money as legally possible in the accounts of the taxpayer. The law requires all who earn money above a certain level to pay a percentage into Federal and state coffers. The law does not require taxpayers pay more than that required by law. Tax planning in a nutshell protects the taxpayer.