Taxes are crucial to financial planning, yet many people only engage with them during the annual tax filing season. The concepts of “tax preparation” and “tax planning” are sometimes mistaken as interchangeable—but they mean two very different things.
Understanding the difference between tax preparation and tax planning can significantly impact your financial strategy and annual and lifetime tax liability. Below, we clarify the differences between the two concepts and explain how both processes work together to enhance your financial strategy.
What Is Tax Preparation?
Tax preparation refers to organizing, preparing, and filing your tax documents. A tax preparer collects the tax documents you’ve been saving and receiving throughout the year (W-2, 1099s, receipts, etc.). It crunches the numbers to determine if you’re better off taking the standard deduction or itemizing. They may also help you find certain credits or deductions you could be eligible for, such as the child tax credit or charitable deductions.
Then, they’ll prepare your tax return, review it with you, determine how much you owe (or overpaid), and file on your behalf. A tax preparer will typically file federal and state tax returns (and local, if applicable).
A tax preparer may be a Certified Public Accountant (CPA), accountant, enrolled agent, or other tax professional. Their primary responsibility is to help you prepare and file a tax return that is compliant and accurate. Most people work with a tax preparer between January and April (the tax return deadline is April 15).
Limitations of Tax Preparation
Tax preparation is, by nature, a reactive process. When you receive your tax documents and provide them to your preparer, there are few opportunities to change your tax status or financial life. The exception is that you can contribute to your IRA for the year up until you file your taxes in the following year. For example, you can make IRA contributions for the 2024 tax year in 2025 until you file your 2024 tax return.
For this reason, tax preparation primarily focuses on your past financial activity instead of any type of future strategy. Although, you may use the information gleaned from the tax preparation process to influence your decisions in the coming tax year. This would lead you closer into the realm of tax planning.
What Is Tax Planning?
Tax planning is a proactive approach to making tax-conscious decisions about your wealth all year round. Tax planning aims to minimize your future tax liability, both for the current tax year and throughout your lifetime (meaning it’s about more than just kicking the tax can down the road).
You can work with your financial advisor to incorporate tax-efficient strategies into your financial plan and regularly review and adjust those strategies based on your changing needs and goals.
Areas Impacted by Tax Planning
What specific components of your financial life could potentially benefit from tax planning? Here are a few common examples:
Tax Bracket Management: Though we use a progressive tax system, the more taxable income you have, the higher your tax bill is going to be. If you’re close to either end of your tax bracket (moving up into the next bracket or down into a lower one), some strategic tax planning could help you reduce your taxable income and drop or maintain your existing bracket.
Tax bracket management also applies to your future tax bracket, say when you’re in retirement and building out your own retirement “paycheck.” Balancing income with varying tax treatment can help you keep your liability in check.
Investment Portfolio: Different investment accounts will receive different tax treatments. For example, your retirement accounts, like a 401(k) or IRA, are tax-deferred. That means your contributions today are tax deductible, but your future withdrawals will be subject to income tax. A taxable brokerage account, on the other hand, does not boast any type of favorable tax treatment. However, it is not limited to age restrictions or required minimum distributions (like a 401(k)). In other words, you can access the funds in your taxable brokerage account anytime.
Another common option is a Roth account. This account has no initial tax savings but can be used to create tax-free withdrawals in retirement.
Capital Gains: You can leverage strategies, like tax-loss harvesting, to offset your capital gains tax liability. Essentially, you may claim your losses and use them to cancel out the tax liability of your profits.
Charitable Giving: If you’re particularly philanthropically minded, you may be interested in incorporating charitable giving into your financial plan. Considering you may only deduct charitable contributions if you’re itemizing deductions, it takes some proactive planning to ensure you optimize your donations’ tax impact.
Tax Planning and Preparation with TFS Advisors
Both tax planning and preparation play integral roles in your financial life—fully optimizing your tax liability requires proactive planning and accurate preparation. At TFS Advisors, we support our clients by bringing tax preparation and planning under one roof. We connect with clients regularly throughout the year and identify opportunities to make proactive adjustments.
This holistic approach to financial planning enables us to empower our clients more effectively to achieve their financial goals while reducing the amount of their hard-earned wealth that is sent to Uncle Sam.
If you’d like to review your current tax strategy and financial planning, we encourage you to schedule a consultation with our team today. We will work directly with your current tax professional to create a holistic plan.
