Tax Return Preparation Versus Tax Planning

Tax return preparation is backward-looking.  It involves reporting what has happened in a particular tax year to the taxing authority.

Tax planning is forward-looking.  It involves making assumptions about the future, and based on those assumptions, implementing strategies to minimize your expected lifetime taxes.  It involves intentionally changing the numbers presented on a particular tax return due to the execution of tax planning strategies.  Examples of tax planning strategies include tax loss harvesting, tax gain harvesting, deduction clustering, and strategic Roth conversions.

As an example, consider a couple whose taxable income in a particular tax year is expected to place them in the middle of the 24% ordinary income tax bracket.  They could consider doing strategic Roth conversions by the end of the tax year to "fill up" the remainder of their 24% ordinary income tax bracket.

Why would they consider doing this?

First, if they think tax rates will go up significantly in the future due to tax law changes.  They may prefer completing a Roth conversion today at a known 24% tax rate rather than in later tax years at what they believe will be higher tax rates.  In this case, they would intentionally pay additional income taxes now due to the Roth conversion if they felt this would reduce their lifetime expected income taxes.

Second, if they expected their taxable income would substantially increase the following tax year and beyond (without any changes to tax laws), which they assume would put them in a higher marginal ordinary income tax bracket.  In this case, they would intentionally pay taxes on the Roth conversion now at the 24% tax rate rather than pay taxes in later tax years at higher expected tax rates.

Conversely, if the couple expected their taxable income would dramatically fall in the following tax year and beyond, such as if they planned to retire, which they estimate would place them in a lower marginal ordinary income tax rate than 24%, they would probably decide not to do Roth conversions now at a 24% rate and instead wait until subsequent tax years, to pay taxes on the Roth conversion at lower expected tax rates.

If you are a prospective client and would like to learn more about hiring us for a financial consultation, where, among other things, we would help you identify tax planning opportunities and provide recommendations on tax planning strategies, please visit our Schedule Meeting page.



Mike McErlane, DO, MBA, CFP^®, CFA^®, RICP^®, EA, MCEP^®

Mike McErlane is the owner and founder of Comprehensive Financial Planning for Doctors, LLC based in Frisco, Texas.

Comprehensive Financial Planning for Doctors, LLC (CFPFD) is an Investment Adviser registered with the Texas State Securities Board.  Registration of an Investment Adviser does not imply any specific level of skill or training.  CFPFD only transacts business in states or jurisdictions in which it is registered or exempt from registration.  A copy of CFPFD's current disclosure brochure is available through the Securities and Exchange Commission's Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov.

The opinions and analyses described are subject to change at any time without notice.  Any information is considered general and is not intended to provide any specific advice or recommendations.  Your use of the information is at your sole risk.  You should consult with your financial advisor, attorney, tax advisor, insurance agent, or other professional advisor before taking action on any information or implementing any strategy.