Tax planning and tax preparation may sound like two sides of the same coin, but the reality is that they are vastly different. All too often, though, business owners and leaders focus on taxes only during tax season—and this means that many miss out on opportunities to legally reduce tax liabilities and retain more cash in the business.
Tax filing season is still months away—but the fall is an ideal time to undertake tax planning well ahead of next year’s filing. Tax planning is important both for the business and the business owner. In this article, we will cover the difference between tax preparation and tax planning and reveal how a strategic approach to tax planning can benefit your business.
The difference between tax preparation and tax planning
Tax preparation and tax planning are both essential for managing a business’s tax obligation. But that is where the similarity ends.
Tax preparation is a compliance process that focuses on gathering and reporting financial data to ensure a business complies with tax laws and files its annual tax returns and pays required taxes timely. Tax preparation is also short-term, taking the current year into account to ensure the proper tax amounts are calculated and paid based on a business’s financial activities for the year.
Tax planning is a proactive, strategic process with the goal of legally minimizing a business’s tax liability. Tax planning entails making informed decisions about business operations, investments, and financial transactions. It takes place well before tax filing deadlines and requires a long-term perspective that considers the effect of business decisions over the next few years—and how those decisions will affect a business’s tax position.
Tax planning can offer huge financial advantages for a business. A recent study of more than 2,000 companies found that businesses feeling the pinch of financial constraints can benefit from taking a more aggressive stance in their tax planning strategies: some were able to recoup nearly 20% of their current investment shortfall by modifying their tax strategies. 1
While these gains were specific to pension funds in the study, the lesson writ large is that most businesses could significantly improve their tax position by engaging in tax planning. Working with a CPA that handles tax preparation is not enough because tax preparation is focused on compliance and the CPA is often not considering the business’s overall situation to identify opportunities to modify tax strategies and legally reduce tax burdens.
The business benefits of proper tax planning
A common misconception is that your business needs to be a Fortune 500 firm or above a certain revenue line to reap the benefits of tax planning. This is not true. Depending on your business and situation, strategic tax planning could reduce your tax burden, enabling you to invest more capital in growing your business. For example, if your business has recently invested in a new building or facility, it might benefit from a cost segregation study that could defer the tax burden.
In general, the benefits of tax planning include:
- Reduced tax liability
- Compliance assurance because tax positions have been reviewed and evaluated
- Time savings
- Long-term planning incorporating tax-efficient strategies
- Access to expertise for complex situations
- Audit assistance, if needed
The benefits of working with a business tax planning professional
Investing in tax planning can be a way to help you protect revenue and grow your business. But it’s important to do it right, with guidance from an expert. The benefits of various tax strategies can vary and selecting one strategy may preclude the use of an alternative strategy. A tax planning professional will help you understand the various options and help you make the right decisions for your business.
In addition, change is the only constant—in business as well as in life. Businesses change with growth. And tax laws change over time. Consider the infusion of pandemic relief and recovery funds and how they changed tax strategy for many businesses. These changes are why tax planning is not a one-and-done exercise, but instead a strategy to revisit annually or biannually with a tax planning professional.
Finally, every business is different, meaning every situation is, too. A tax planning professional analyzes your business as a unique entity, considering revenue, income sources, expenses, investments, and more. Ultimately, the tax planning professional identifies specific opportunities to reduce the tax burden, accelerate costs, increase deductions, and more. This can help to free up working capital, or even help business owners have access to additional income to meet personal obligations like retirement investments or tuition payments.
When you are ready to reap the benefits of tax planning, XPECT can help. XPECT professional services are designed to support the unique and specific needs of small and mid-size businesses. XPECT is focused on helping businesses optimize business strategy, enhance operational effectiveness, and successfully leverage accounting as a strategic tool, so that business leaders can focus on the strategic aspects of growing the business and achieving business goals. Learn more at www.xpectup.com.
1 NC State University. “Study Highlights Benefits of Tax Planning for Companies Facing Financial Constraints.” NC State University press release, April 5, 2021. On the NC State University website. https://news.ncsu.edu/2021/04/taxes-and-financial-constraints/.