7 minute read
Most people, including many CPAs and tax professionals, don’t understand the difference between tax projections and tax planning. Confusion reigns because tax planning is rarely, if ever, taught in university accounting departments. Typically, graduates going into the world of accounting have never even broached the topic of tax planning. Is it any wonder then that tax planning gets merged with the idea of tax projections?
In order to stop the confusion, we must define the terms. A tax projection uses current income and expenses to project taxable income for the entire year. Why do people need tax projections? It allows an estimate of tax due.
The positive of this service is it helps set aside money for future taxes owed, but the negative is that it does nothing to actually help save money on taxes. Tax projections are incredibly useful in their place — but they are limited in what they can provide. Tax planning, meanwhile, goes beyond mere tax projections.
Tax planning goes further than tax projections by proactively seeking out strategies that can be applied to legally reduce taxes based on a person’s life, business and any applicable regulatory requirements. One way to think about it is whether you would rather just know what you’ll owe in taxes… or know how much you can save yourself in taxes.
This is why tax projections and tax plans are two completely different services. Tax projections are knowledge-based while tax planning is utilitarian. Typically, tax firms that do tax planning find their clients get greater value from a tax plan than a tax projection.
There are multiple choices when it comes to software options. Tax projection software, as well as tax planning software, should offer users the ability to upload tax returns. Also look for software that seeks to always stay up-to-date with the latest legislation, otherwise you could be getting outdated information.
If you just want detailed reporting on how much tax you can expect to pay, projection software will be good enough. If, however, you want to actually reduce your tax bill, you will need a good tax planning software that calculates potential strategies for you.
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The short answer is that it depends. Obviously, everyone’s tax situation is unique. Credits and deductions that can work for some may not for others. Typically, the more money one has, the more potential savings they can find. This is because those who earn less usually don’t have much tax to pay to begin with.
If a person owes the IRS $800, tax planning software may find some small tax-saving strategies to lower that, but if a person owes $80,000 there is bigger potential for significant savings. The same can be said for businesses. Tax planning software can help optimize the legal entity of your business to secure the largest savings amount possible.
In summary, while any taxpayer could benefit from having accurate tax projections, big opportunities can arise for taxpayers who have a more sophisticated financial picture and want to invest in tax planning.
Remember, tax planning is the process of looking at your life, business and regulatory requirements to legally reduce taxes. If you can do that on your own, then you don’t need specialized software. However, you may feel intimidated by the US tax rules, which are ridiculously long — literally tens of thousands of pages.
Even the majority of seasoned CPAs feel they don’t have enough information to do a comprehensive tax plan on their own. Sure, they can find a strategy here and there, but if they want a complete tax plan that takes into account hundreds of strategy combinations, they’ll go to tax planning software to do the work for them.
After all, who has the time to learn all the tax laws that could apply to their specific situation? Letting tax planning software do the calculations speeds up the process and finds more potential savings than planning manually.
Of course, any time is better than never. With tax projections, a good time would be whenever you want to gain insight into your future tax situation. With tax planning, it pays to do it sooner rather than later. This is because you may not have time to implement the strategies for the current tax year if you wait.
In addition, if you wait until tax season, a time-sensitive opportunity may have already passed by. For example, under the Tax Cuts and Jobs Act, tax benefits associated with deferring capital gains in Qualified Opportunity Funds (QOFs) could be available. If you sold an asset in June and then waited until the following March to do a tax plan for the year, it would be over the 180-day limit from the date of sale to invest in a QOF. In other words, it would be too late to take advantage of the strategy.
This is just one example of why tax planning should be done sooner rather than later, and it should be something you continually monitor as your personal circumstances change along with tax law changes. Tax projections are great, but tax planning can be superior if you’re looking to save money.
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