While most people understand the importance of tax planning, many don’t know the difference between a proactive and reactive approach.
Most people are reactive when it comes to their income tax. They wait until the end of the year to gather all their paperwork and data, and then they take it to a tax professional to have them prepare the return. While this is certainly one way to do things, it’s not the most proactive or strategic approach.
Many tax professionals take your raw business data after the end of the year, when not much can be changed, and enter it into your return. However, it is a huge advantage to work with someone strategic who can help maximize your assets and deductions and create a plan for the coming year.
What is the Difference Between Proactive and Reactive Tax Planning?
Regarding tax planning, there are two main approaches: proactive and reactive.
Simply put, proactive tax planning is working with a tax professional throughout the year to create a plan. This approach has many advantages, including avoiding mistakes, maximizing deductions, and being prepared in advance.
On the other hand, a reactive tax plan is one in which you wait until after the end of the year to take action. This is often the approach taken by people who procrastinate or don’t understand how the tax system works and how to use it to their advantage.
Reactive Tax Planning
Reactive tax planning is when you take no proactive measures during the year to minimize your taxes and instead wait until after the end of the year to gather all your data and information for your tax return. This might include scrambling to find receipts in the new year and being stressed about the unknown. The numbers are then plugged into the software to determine how much you owe and accept things as they are.
If you’re not actively working to minimize your taxes throughout the year, you’re likely paying more than you need to. This approach can often lead to mistakes as you rush to finish everything at the last minute. It can also be more expensive, as you may not be able to take advantage of certain deductions or tax breaks.
Proactive Tax Planning
Proactive tax planning is when you take steps throughout the year to minimize your tax liability, which gives you a clear advantage come tax time.
This might include maximizing deductions, setting up a retirement account, or investing in particular assets. Proactive tax planning can help you take control of your finances, avoid mistakes, save money, and be better prepared for tax season.
Some examples of proactive tax planning:
- Contributing to a tax-sheltered retirement account – This can help you reduce your taxable income for the year, and it also allows you to save for retirement. The key is to know which account to contribute to and how much based on your financial situation.
- Making estimated tax payments throughout the year can help you avoid any penalties or interest that may be charged if you owe money on your taxes. The key is not to underpay or overpay in income tax but to get as close to the correct amount as possible.
What Does Proactive Tax Planning Look Like?
There are a few critical components to proactive tax planning.
First, you need to work with a tax professional who can help you understand the tax system, maximize your deductions and other financial opportunities, and meet with them regularly. A trusted tax professional will know what to look for and the right questions to ask to help you make the best decisions for your business.
Second, you must keep good records throughout the year to easily prepare your return come tax time. Keeping good records will help your accountant be able to help you minimize your tax liability by being able to clearly see your financial picture.
Finally, you need to create a plan for the coming year so that you can be prepared in advance. A good tax plan will save you money and help you avoid mistakes.
Take a Proactive Approach to Tax Planning
Don’t wait until tax time to start thinking about your taxes. Work with a tax professional throughout the year to ensure that you take advantage of all the deductions and credits you are eligible for. This will help you minimize your tax bill and keep more money in your pocket.
Proactive tax planning is the key to a successful tax strategy. By being prepared and taking action throughout the year, you can save money, avoid mistakes, and be in control of your finances.
If you’re ready to take a proactive approach to tax planning, Shetland Financial can help. We work with clients throughout the year to help them determine the most tax-efficient business structure, maximize their deductions and save money come tax time. Contact us today to learn more.