Tax Planning vs. Tax Preparation (And the Pros of Being Proactive)
Most Americans, whether individuals or business owners, have annual tax filing obligations that they deal with during “tax season,” generally late January to mid-April. Organizing and putting together those filings is what’s known as “tax preparation.” And tax preparation is a backward-looking exercise.
Tax planning, on the other hand, isn’t obligatory at all. You could, in theory, go the entire year without giving a thought to that year’s tax returns, which you’ll file the next year.
You could … but you probably don’t want to. Because this very forward-looking practice can have a meaningful (positive) impact on your company’s cash flow, growth strategy and long-term profitability.
What Is Tax Preparation?
Tax preparation is the process of compiling financial data from the prior year and using it to complete and file required tax returns. And as previously mentioned, individuals and businesses alike usually don’t deal with this except for the period between late January (the “official” start of tax season) and Tax Day, usually April 15.
Tax preparation is largely historical. It answers the question “What happened last year, and what do we owe as a result?”
By the time you’ve reached the tax preparation phase, virtually all decisions that affect your tax bill have already been made. Revenue has been earned. Expenses have been incurred. Purchases have been completed. Structuring decisions are set.
In other words: Preparation ensures compliance. It helps you file accurately and on time. But it offers limited opportunity to change the outcome.
What Is Tax Planning?
Tax planning, on the other hand, is proactive. It focuses on anticipating tax consequences before the year ends, and before key financial decisions are finalized. And theoretically, businesses can work on tax planning all year long, from Jan. 1 to Dec. 31.
Tax planning involves asking questions like:
- Should we accelerate or defer income?
- Does it make sense to invest in equipment before year-end?
- Are we maximizing available deductions and credits?
- Is our entity structure still optimal? / Should we change our business structure?
- Should we adjust estimated payments to avoid penalties?
- Were there any important tax changes recently that will materially impact our liabilities?
Rather than documenting what already happened, tax planning helps shape what will happen.
Done properly, it’s a year-round process that aligns tax strategy with broader business goals, whether that’s expanding operations, managing cash flow, reinvesting profits or preparing for a sale.
How Proactive Planning Saves Money
Waiting until tax preparation season to think about taxes can be expensive. Here’s why.
1. You Lose Flexibility
You might discover that you accidentally qualified for a few tax breaks during the preparation process (after the tax year is over). But you typically need to put most tax-saving opportunities into motion during the tax year — in many cases very early on in the year. Examples include making certain retirement plan contributions, timing capital expenditures, harvesting gains or losses, and structuring compensation and/or bonuses.
The earlier you plan, the more flexibility you have in trying to meet tax-break qualifications.
2. You Might Overpay
Compliance-focused preparation ensures you meet your obligations. Strategic planning helps ensure you don’t pay more than necessary.
For instance, with tax planning, you can ensure you’re fully leveraging depreciation options, claiming all eligible business credits, and efficiently structuring your compensation and distributions.
Without periodic review, it’s easy to default to the same approach year after year, even if your business circumstances have changed.
3. You Risk Cash Flow Surprises
Unexpected tax bills can strain cash flow, especially for growing businesses reinvesting profits into operations.
Year-round planning can help you more accurately project your tax liability. By adjusting estimated payments and reserving funds appropriately, you reduce the risk of scrambling for cash at filing time.
Ready to Be Proactive About Taxes?
Tax preparation is downright mandatory, but it shouldn’t be the only time you think about taxes. Strategic, year-round planning can help you make better business decisions, improve cash flow predictability, and potentially reduce your overall tax burden.
McManamon & Co. is an accounting, tax, fraud, forensic and consulting firm serving small and midsize businesses. Our experienced tax team provides not just tax preparation services, but also proactive tax advice.
Call McManamon at 440.892.8900 or contact us online today to discuss how thoughtful, year-round tax strategy can help your business move forward with confidence.
Tags: McManamon, McManamon & Co., small business taxes, tax planning, taxes | Posted in McManamon & Co., small business taxes