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Why It’s Critical to Integrate Tax Preparation with Your Financial Plan

by | Feb 22, 2023 | Business

Two Traders Discussing

For many people, reviewing their financial plan and preparing their taxes are mutually exclusive events, meaning they tend to treat them separately as if one didn’t impact the other.

Many often review their financial plans once or twice every few years whenever they can get in to see their advisor. Tax preparation typically occurs sometime after the first of each year and without any specific consideration for their financial plan.

But, wait! This can be a dangerous mistake, especially for anyone looking to maximize their tax savings for the benefit of their financial goals.

After all, taxes can put the biggest drag on building wealth over time. 

Difference Between Tax Preparation and Planning

First, it’s essential to understand that tax preparation and tax planning are not the same.

Tax Prep

Having a tax professional prepare your taxes is essential for ensuring you comply with federal and state tax laws. A well-qualified tax preparer may even help you find ways to maximize your deductions and credits for saving taxes. They will ensure your forms are completed correctly and filed on time and then bid you farewell until next year. But… that’s about it.

Tax Planning

But tax planning is the process of analyzing your financial situation or plan and coordinating all elements to ensure you don’t pay any more taxes than necessary.

Tax planning is a year-round activity that involves a deep dive into your current financial circumstances to assess where you are in relation to your financial goals, with attention to how the tax laws impact your cash flow.

Your Tax Situation Should Inform Your Financial Decision-Making, and Vice Versa

However, tax planning shouldn’t be done in a vacuum as it can be critical to informing vital financial planning decisions. A good tax advisor works in concert with your other advisors to ensure your tax situation properly informs your financial decision-making for the year and vice-versa. Your current financial situation should also inform your tax planning.

But, don’t just take our word for it. Here’s a true-life story to illustrate our point:

After handing over their 1099s to their tax preparer, a business owner was stunned to learn that their mutual fund holdings generated over $50,000 in capital gains for the year for which they owe taxes. They were perplexed because they didn’t sell any shares that year. How could they owe taxes if they never sold? 

The tax advisor showed the client the 1099 from the mutual fund showing the capital gains distributions and explained how they result from buy and sell transactions the fund manager makes. At that point, one month before the tax filing deadline, there was nothing they could do except pay the taxes.

Had the tax professional worked collaboratively with the business owner’s financial advisor throughout the year, they could have gotten in front of the looming tax liability, possibly reducing its impact. They could have applied a tax-loss harvesting strategy to offset some gains. Or recommended the client convert some underperforming mutual funds into exchange-traded funds with minimal buy-sell transactions.

The same business owner also saw their tax liability increase substantially because they paid themselves additional compensation through bonuses. A good tax planner keeps tabs on a client’s tax situation throughout the year to ensure they avoid pushing themselves into a higher tax bracket. A tax preparer can only report the earnings increase after the fact, but a good tax advisor can find the best way to structure the compensation to minimize its tax impact. That conversation should start well before yearend by studying tax projections based on different options.

The Value of Advisor Collaboration

The challenge for many people is that without help coordinating the critical aspects of their financial plan, they are often left holding the various pieces of their financial puzzle without an overall picture of how they’re supposed to fit together. It isn’t easy to put a puzzle together when you can’t see a picture of how it is supposed to look.

That’s why an increasing number of clients are seeking a more holistic planning approach through a collaborative team of advisors. Ideally, for the most effective coordination and optimum use of resources, the advisor team works together under one roof. Or you can look to your financial advisor at the quarterback to coordinate the efforts of your own team. Either way, you’ll be better equipped to avoid tax surprises that can adversely affect your financial plan.

The better aligned your tax and financial plans are, the more money you get to keep. 

*The LPL Financial registered representatives associated with this website may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state.

Securities and Advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.. Trivium Point Advisory and LPL Financial are separate entities. Tax and accounting related services offered through Trivium Point Advisory LLC, DBA Trivium Point Advisory, LLC. Trivium Point Advisory is a separate legal entity and not affiliated with LPL Financial. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for individualized tax or legal advice. Please consult your legal advisor regarding your specific situation. LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.

LPL Financial does not offer tax or legal advice or services

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

This article was prepared by Lexicon Advisor Marketing. This article was prepared for Trivium Point Advisory’s use.

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