Consider first the difference between a tax return and a tax plan. A tax return is the result – the final statement of your taxes due to or from the government; the tax return is produced after the end of the tax year. A tax plan is a creative and scientific process of forecasting your taxable income and then adopting a proactive set of strategies to ensure compliance and maximize your cash flow; the tax plan is developed before the end of the year. Let’s examine the elements of a tax plan:
- Forecasting your taxable income: Any meaningful tax plan must start with a careful estimation of your taxable income for the year. This will include your personal income from wages and investments, business income, and rental income, minus allowable deductions. If you are a business owner, the process of forecasting your business’ net income gets easier as you get closer to the end of the year – for this reason, the best tax planning is generally done in November or early December.
- Ensure Compliance: The IRS wants you to pay your taxes “as you go” throughout the year, not all at the end. If you are self-employed, this means making quarterly estimated payments. Shareholders of a business taxed as an S-Corporation can receive W-2 wages and withhold taxes from those wages. Either way, those quarterly payments or with-holdings are supposed to be set up to equal your total tax liability for the year. That is hard to do with precision, and so the IRS (and the states) long-ago established “Safe Harbor” minimums that, if satisfied, ensure that even if you underestimate your taxes, you will not be subject to penalties or interest. For business owners, one of the first things you and your tax advisor must do is to calculate your Safe Harbor minimums and then make sure you have at least those amounts paid in prior to December 31.
- Maximize Cash Flow and Savings Opportunities: This is another way to say “Minimize my Tax,” but bear in mind that the goal of a good tax plan is not necessarily to pay as little tax as possible this year; the goal is to maximize your personal cash flow and savings over time, not just right now. You may know about pending changes in your business profits and/or pending changes in tax laws that create opportunities for greater tax savings in future years. Any good tax plan is developed in context of at least a two year-forecast for your business.
This is complex analysis, and it also requires expertise in the multiple types of retirement plans which offer deferral of tax and help you save for your long-term future.
Check back with us in two weeks when we will look deeper at a couple of numerical examples and CLM Advisors “success stories” with tax planning.