Why Start Tax Planning (and Preparation) Early?

It’s that time of the year again—taxes, taxes, and more taxes! And we’re creating a three-part series that tackles your most pressing tax questions. Part 1 breaks down the top benefits of tax planning and preparation early in the year. Believe it or not, taxes aren’t just a dreaded springtime chore; there are ways to plan and optimize them for long-term savings.

What’s The Difference Between Tax Planning and Tax Preparation?

There’s a significant difference between tax planning and tax preparation. Everyone has to do tax preparation, which is the annual process of filing a tax return to the IRS. However, several investors miss out on the benefits of tax planning, a year-round process that optimizes their comprehensive tax situation. Let’s take a closer look at each—and see why they’re both critical. 

Tax Planning

Tax planning is a holistic process highlighting short-term and long-term tax strategies that ultimately reduce your total tax liability and keep more money working for you. While tax planning can help you consider your tax situation year over year, it also allows you to look at the long-term tax impacts of a specific decision. Take a Roth conversion as an example. Typically, when you’re doing a Roth conversion, you’ll have a specific tax liability on the amount you convert, which could mean you’ll owe a little bit of money come tax time. But the long-term benefits of tax-deferred growth and tax-free withdrawals in retirement far outweigh the short-term costs—at least in this ideal case. Tax planning is a strategic, forward-thinking process that enables you to be proactive about your money. You can approach several financial conversations from a tax angle, like:

• Exercising, selling, and/or holding your stock options

• Long-term investing in an HSA

• Roth conversions

• Charitable giving, Donor Advised Funds (DAFs), and Qualified Charitable Distributions (QCDs)

• Asset location

• Retirement withdrawal strategies, and more.

While taxes certainly aren't the only factor to consider when making a financial decision, understanding the potential tax impacts brings more color, depth, and dimension to your financial choices.

Tax Preparation

Tax preparation is the practice of filing your income tax returns to the federal and state governments—what you typically think of when you hear the word "taxes." While a necessary piece of your financial life, tax preparation is reactive. Once January hits, there aren't too many strategic moves you can make to impact your tax bill come April. That’s not to say there aren’t some action items to consider for your upcoming return. For example, you can still contribute to your IRA before the standard tax deadline for the previous tax filing year. So, you can contribute to your 2021 IRA by April 15, 2022! The same is true for your HSA. Doing so may lower your taxable income and boost your savings. While there are some short-term moves at your disposal, several more strategic opportunities before year-end to positively impact your tax picture in the coming filing season.

The Benefits of Tax Planning Early In The Year

The earlier in the year that you start thinking about taxes, the better. This doesn’t mean that taxes should consume every financial decision you make. But the more you stay organized, the easier it will be to make tax planning decisions before 12/31. By starting early and revisiting quarterly, you can evaluate potential opportunities and have time to create a solid plan. You may ask the following questions:

• Is your company going public this year?

• What sort of equity compensation do you have this year? Are any shares vesting soon?

• Does a Roth Conversion make sense this year?

• Can you optimize your charitable giving strategy with a DAF, bunching donations, donating appreciated assets, etc.?

• Should you strategically realize some capital gains?

• Are you starting the 5-year retirement clock?

• Do you have any new income sources?

By monitoring your income and taxable events as the year progresses, you can make informed decisions throughout the year and decide what tax-saving strategies you can deploy to improve your overall tax picture.Knowing your yearly goals can help us shape your financial decisions in a tax-friendly way.

Why File Your Tax Return Early

There are several reasons why the early bird gets the worm when it comes to filing tax returns. First, you avoid the tax rush, giving you and your CPA (or Tax Professional) more time to ensure everything has been accounted for. Doing things right the first time can help you avoid filing an amended return, requesting an extension, or missing the deadline altogether, leading to penalties and fees. Early filing also helps protect against identity theft — a prevalent crime come tax time. You’ll also have quicker access to your refund—though if it's a significant check, it's time to update your W-4.

Make A Long-Term Tax Plan That Works For You

Taxes will always be part of your financial picture, so it's essential to work with a professional who can help you chart the best path forward. At the Dala Group, we’re passionate about helping you create a comprehensive financial plan that puts you on the path toward reaching your goals. Taxes are significant in anyone's financial plan, and being smart about proactive tax planning is fundamental for future success! We would love to help you optimize your financial plan and ensure you aren’t missing out on the financial strategies that will put you in the best position long-term. Reach out today.