Tax preparation vs. tax planning – which do you do?

Last month, I invited my clients, Facebook and Twitter followers, friends, family, and other contacts to participate in Money Coaches Canada’s Money Monday event “Tips to Minimize Your Tax Bill”.

The response was very positive.  Most people HATE paying tax and would like nothing better than to reduce the money they send to Ottawa every year!  However, a few responses I heard are concerning.

One, “I use tax software.  It figures everything out so I don’t have to think about it.”

Another, “My accountant does my taxes.  I just give her all my receipts and she takes care of it.”

<Sigh> Unfortunately, the hardest people to help are those who sincerely believe they are doing the right thing, but sadly aren’t.  So what’s wrong with this mindset?  The problem lies with folks focusing exclusively on Tax Preparation, and NOT on Tax Planning.

What’s the difference, you ask? Well, I’m glad you did!

Tax Preparation is the process of completing the relevant tax forms in a T1 return, based on last year’s financial circumstances. You provide the required data, and the tax preparer tallies up the numbers and tells you how much you owe, or will receive as a refund. Often, there isn’t much context provided. It’s a case of “Just the facts, ma’am!”

Tax Planning, on the other hand, goes MUCH further and is all about context.  It is an on-going process that looks at your current and anticipated circumstances.  It asks the question “How could I arrange my affairs to be more tax efficient, both now and in the future?”

Some examples of Tax Planning:

• Perhaps you shouldn’t deduct your entire RRSP contribution on your 2012 tax return because you expect to get a sizeable bonus in 2013. You may save significantly more tax if you deduct it on your 2013 taxes instead.
• Perhaps your investments should be structured to shelter highly-taxed income, and to benefit from favourably-taxed dividends.
• Due to different marginal tax rates, perhaps one spouse should invest largely for dividends while the other invests for capital gains, thereby reducing your family’s overall tax burden.

Often, your tax software or accountant doesn’t know how your portfolio looks today, or what you plan to change about it in the coming year – all they see are last year’s little tax slips.

Please, please, PLEASE ensure that effective Tax Planning is part of your financial arsenal, not just competent Tax Preparation. Both are important, but each is incomplete without the other.

For more information, speak with your Money Coach or Financial Planner.