Ep. 59 | Tax Planning vs. Tax Preparation
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Speaker 2:Welcome back to the podcast, everybody. Today on episode 59, we are gonna jump head first into what the difference is and similarities between tax planning and tax preparation. So sure, we'll give the definitions of them, but more importantly, we're gonna talk about how they play so perfect together in the proverbial sandbox. But before we do that, let's take a brief moment as always. Thank our sponsor.
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Speaker 2:As you heard in the intro, episode 59 today, it's a lot of episodes. And as you've probably heard in other episodes that we've done, we've always kinda talked a little bit about tax planning and tax preparation and really what the difference is. So that's why we're here today. Chris Pacuro, welcome back to the show, my man. How are we doing today?
Speaker 4:I am awesome, John. I hope you had a great Thanksgiving with your family.
Speaker 2:I did. You as well. Hopefully, we're not still in a food coma considering that was, what, four days ago or so. So now that we pop out of that and come to the realization that it is now snowing in the wonderful state of Michigan, which we don't wanna talk about, and I'm sure it is absolutely beautiful in Tennessee, which I don't wanna talk about. Let's let's talk about prep and planning and really what the difference is.
Speaker 2:Right? So as any taxpayer goes in The United States Of America, they've most, we should say, they have. Most have probably taken part in tax preparation, but probably not tax planning. So I'll kinda leave it up to you a little bit. Maybe draw that line in the sand for us really between the two or or what the difference is and and how they kinda play nice together.
Speaker 4:Well, I'm glad that you'd set it up like that, John, because what we have to understand is that tax planning and tax preparation are two completely different activities. That being said, they should complement each other. It's not one or the other. So tax planning and strategy is very proactive. Tax preparation is very reactive and compliance driven.
Speaker 4:So tax tax preparation is something that you have to do every year, assuming that you're required to file a tax return, where tax planning is unfortunately very optional. And we know based on a survey from Intuit recently that only 18% of, tax firms lead with tax planning and strategy. So unfortunately, most people do not partake in any type of tax planning and strategy, but guess what? If you're listening to this show, that means you already are. You're already interested in it and that's why we birthed teaching tax quote.
Speaker 4:We want to empower people to legally and ethically reduce the tax they pay in their lifetime. Now, there are a lot of different, definitions of tax planning, but let me read one from Investopedia that we like to use in some of our presentations just to give the listeners an idea of what it is because it can be a little bit intimidating. Tax planning, quote from Investopedia, is the analysis of a financial situation or plan to ensure that all elements work together to allow you to pay lowest taxes possible. A plan that minimizes how much you pay in taxes is referred to as tax efficient. Tax planning should be an essential part of an individual investor's financial plan.
Speaker 4:So that, again, we know that taxes are a lot of times the biggest financial burden for people. So this is part of your overall financial plan, reduction of tax liability, and maximizing the ability to contribute to retirement plans are crucial to for success. Now we do know, and I'm a big advocate of contributing to retirement plans, we have a lot of discussion in, our community, teaching digital community, and and on this podcast about different types of retirement plans and how some retirement plans like a Roth allow you to grow your money tax deferred and then ultimately take it out of the account tax free where traditional IRAs and four zero one k's work a little differently. But that's in it. That's a 30,000 foot view of what tax planning is.
Speaker 2:And then really with tax prep. So tax prep really is just just that. It's preparing annual forms, submitting. That's where you're usually working with, you know, your your tax professional, whether it's, DIY, H and R Block, anybody else in the world. So that kinda comes around every year.
Speaker 2:Now is tax planning something that somebody does every year, or is this something that, you know, you suggest maybe every couple years? What does that look like, or what is a good this sounds really cheesy, but what's a good plan to plan when it comes to taxes?
Speaker 4:Exactly. Well, we believe in teaching tax flow that your tax return is a verb and not a noun, and the tax planning should be occurring all year round. Now we are in the fourth quarter of the year, so we know that at this point, this is the peak time for implementation for tax planning. Yet, it is something that should be considered all year round. Now, you don't have to every day do a tax plan.
Speaker 4:We would recommend that you look at your tax situation in-depth at least twice a year if you own businesses or own rental properties and or if you have a significant financial event. At that point, then you should really do look at doing some tax planning. What what are some examples of that? It could be changing jobs. It could be, it could be sizing stock options.
Speaker 4:It could be selling a property. It could be starting a business. It could be retiring. There are a lot of different things that that could precipitate saying, okay. I need to have a plan for that specific transaction.
Speaker 4:So tax prep, it's the ghost of Christmas past. It's looking back at the previous year and putting a tax return together. Tax planning is the ghost of Christmas future, and it's that ongoing process. And, John, I know I I talked about this on our text tip Tuesday, but the best way to describe it is that imagine that you I've said now, John, you're you know, people understand, beyond the the the boy band good looks of yesteryears and the the tips, the, the bleached tips.
Speaker 2:Oh, I If you dive back it's back.
Speaker 4:Yeah. If you dive in the deep web, you're gonna realize John Topolsky is also a general contractor, as a general contracting license. One of the most handy handy guys I know. So the thing is, is you as a builder, you might be able to do this. Right?
Speaker 4:But if I went to an average person, and said, hey, I want you to build a house out of Legos, and I just dumped a crap load of Legos on a kitchen table. You might be able to muddle through and build some type of structure. You it might it might be really simple and small, or it could be elaborate, but it might not be it might be this color, meaning there's yellow Legos and green Legos connecting. You're probably gonna start building it and have to tear it down, But you might get it together and build some type of house, but you're probably not gonna absolutely love what you built. And it's probably not the best house that could have been built based on those Legos.
Speaker 4:But there's also time constraints. Right? Just like tax returns, there's there's deadlines. But what if I gave you the same amount of Legos or but I gave you them in a box that with instructions that's sealed specifically for a house. So, John, I know you have a young daughter.
Speaker 4:So what if what if your daughter received from Santa Claus Cinderella's castle? Should be one heck of a Lego set.
Speaker 2:Yeah. That would that's called a clear
Speaker 4:Yes. But imagine you, she gets a house a play set for a house, and you have all the LEGOs, exactly the ones you need, maybe a couple extra. You have the stickers, and you have, guess what, instructions to build that house. That's tax planning. Both in both exercises, you end up with a house, but one's exactly what you want and get you get the best result possible because you are you have a little help, right?
Speaker 4:So you have the instructions, you have the guidance, but you have planned in advance to build that house versus, oh, crud, it's end of the year and I have to have my tax return submitted to the IRS. Let me grab my documents and and submit it and hope for the best. So that's a really again, you're still getting a house, but what kind of house do you what is your what do you want your tax return to look like? And by doing the proper planning, you can legally and ethically reduce the tax you pay in your lifetime by manipulating the numbers that go on your tax return. And we always you know, manipulating sounds like a bad word, but it's really not when it comes to when it comes to this.
Speaker 4:So just like John, I'll give you one more example then I'll I want your feedback on on the construction, but one more example would be with applying for a mortgage. You know, when you apply for a mortgage and we've got Brenda Carl's on, the show and and talking about mortgage prep. If I told you tomorrow, hey, you're applying for this mortgage, you're gonna get the your credit they're gonna pull your credit score and you're just and take a snapshot of your of your finances. Well, we know that there's you know, when you're applying for a mortgage, a lot of times you wanna pay down your debt, you want to season your money, you wanna make sure that, your your usage of any type of credit cards, etcetera, are at a below a certain level. In other words, you're make putting yourself in the best position possible to apply for that mortgage.
Speaker 4:And that's that's the same thing with tax planning.
Speaker 2:And really, Chris, so so really when it comes down to tax planning, so obviously that is laying the the groundwork, you should say, for any activities that that, you know, would give you the best outcome possible at the end of the year. But from your side of it, from doing tax prep for a while and being a part of these conversations and planning, has anybody ever tried or we'll just call it, I can't think of an example specifically. I'm sure you can, but where somebody may come and meet with you and they're very excited about what they're going to do. Right? And you're just meeting before the end of the year, and and you pretty much look at them and be like, well, if you do that, it's not gonna do anything positive for you.
Speaker 2:In fact, it's gonna hurt you, and you would have known that if you would have planned for that a little bit earlier in the year. I don't know if you know any examples or you can share, you know, any cases with us like that, but really that from what I'm taking from this, right, is is planning is just that. It's not the actual action of doing anything. It's laying all the cards out of the table, organizing them or we'll say, you know, Legos. In this case, I love that example.
Speaker 2:Laying all the Legos out and saying, you know what? It's better for me and my family and my future and and really this year and next year, etcetera. If I just build this over here instead of trying to use every piece and hobble something together, that'll work great this year, but it's gonna fall apart and hurt me in the the following year. So can you think of any examples maybe you'd be willing to kinda walk us through that may have fallen flat on
Speaker 4:their face? Absolutely. And, you know, I just thought of another analogy. It's just can you imagine playing Uno? Think about you're playing Uno.
Speaker 4:I get to look at my cards and play a card, and you just have to randomly take one and flip one over. Who's gonna get you might flip over a wild or pick four, but, again, isn't it better to see the cards? So imagine you're playing with the IRS, and that's that's tax planning for Sprout. Yeah. Absolutely.
Speaker 4:So one of the other laws of tax planning is that cash flow doesn't equal tax flow. And what I mean by that is let me give you an example of exactly what I I mean, you know, in our private CPA practice, our clients are very engaged in their tax planning and strategy. But sometimes, we have someone come to us and say, hey. I, you know, I I bought this house for $200,000 as a rental. I sold it for $600, so I got, you know, I again, minus depreciation, recapture, and all this, but I made $400,000.
Speaker 4:But don't worry, I went and bought a piece of land, you know, because I'm gonna I'm gonna build a cabin that we're gonna use as our family. Now, that's cash flow versus tax flow. There's no deduction for buying land. In fact, land isn't even depreciable. The person didn't do a ten thirty one exchange.
Speaker 4:So what's happened is a person has a $400,000 taxable event. Let's say they owe a hundred thousand dollars of tax on that, but they don't even have any money left because they put it all back into a piece of land that's not a deduction. So absolutely, we run into people making s corporation elections and and subjecting themselves to a significant amount of compliance cost when they're not when their income level isn't at the point where it makes sense or their fact pattern doesn't make sense. We see people taking money out of retirement accounts prematurely, to solve a problem instead of maybe exploring other options. I'll We'll give you one more example.
Speaker 4:Let's say we had a client. I hate to say client because I again, our private CPA for clients are are really good with tax planning. But let's say you have a taxpayer that has a has a home. They have a home equity line of credit of a hundred thousand dollars. And let's say they need to make something goes terrible at the house and they need to put $30,000 into the property.
Speaker 4:They might they might instead of using their home equity line of credit, which is not taxable, they might yank the money out of their retirement account as a knee jerk reaction, and guess what? It's taxable. And if they're not 59 years old in general, they're gonna pay a 10% penalty. So that could cost them 40 thou 40% pretty quickly, especially if they live in a taxable state. So that's why I said, when should you do tax planning?
Speaker 4:If you have a significant event financially in the during the year to at least consider planning for that transaction. We're not now that the roof got blown off your house, we're not telling you, hey. Wait. Don't put a roof back on or wait till the insurance company get it. But we're saying, let's be tax efficient with our financial decisions.
Speaker 4:I'm gonna touch real quick on, you know, what people should do as far as what type of process they should use for tax planning because I think it's pretty common knowledge now that that tax planning and strategy are very important. And we get a lot of tax professionals actually listening to this podcast as well, but where just like if John, if you said, hey, Chris, you know, you really need to get in shape. You gotta eat better and exercise. Okay. That's great.
Speaker 4:Thank you so much. But what if I don't know how to exercise? You might tell, what if I've never had a running coach? What what if I've never been to a gym and lifted weights? And what if I've never shot a basket or, grabbed the pickleball paddle?
Speaker 4:You know, we had to throw it in there. But what what if I never did that? What if I never had any education about my nutrition? You never read the side of a bottle. Like, when I was growing up, thank goodness, you didn't know how many calories were in anything, and it was pretty enjoyable, actually.
