Tax Planning and Preparation
Tax planning and preparation is the process by which individuals and businesses navigate the complexities of tax codes and paperwork to accurately report their income and minimize tax liability. This involves understanding various elements such as Adjusted Gross Income (AGI), which is the total income after deductions, and the potential benefits of tax credits, like the Earned Income Tax Credit (EITC), designed to support low- to moderate-income workers. Many taxpayers rely on certified public accountants (CPAs) for their expertise, especially when dealing with complex financial situations or seeking to maximize deductions. However, a significant number of people opt to prepare their own taxes, often utilizing tax software that simplifies the e-filing process, reduces costs, and improves convenience.
Despite the availability of resources and technology, the intricacies of tax laws can be daunting, leading many to seek professional help to ensure accuracy and compliance. Successfully managing tax obligations not only requires knowledge of available deductions and credits but also an understanding of the broader tax environment, including local, state, and federal policies. Overall, tax planning and preparation is an essential practice that allows taxpayers to fulfill their legal responsibilities while potentially reducing their financial burden.
Tax Planning and Preparation
Tax planning helps a taxpayer find his or her way through a maze of paperwork and tax codes. There are a number of resources available to help taxpayers prepare their annual reports to local, state and federal revenue agencies. By exploring these aspects of tax planning and preparation, the reader will better understand both the planning schemes and the environments of tax policy and reporting. A synopsis of the number of ways tax planning may take place in the course of preparing an income tax return is provided.
Keywords: Adjusted Gross Income (AGI); Certified Public Accountant (CPA); Deductions; Earned Income Tax Credit (EITC); E-Filing; Tax Liability; Tax Software
Overview
The iconic economist, John Maynard Keynes, once quipped, "The avoidance of taxes is the only intellectual pursuit that carries any reward"
(http://www.quotationspage.com/subjects/taxes/). Paradoxically, taxes are simultaneously one of the most loathed and most invaluable components of any political system. They are despised in popular circles because they draw away from our personal incomes, add cost to the goods and services we buy and are imposed on our personal belongings such as cars and property. At the same time, taxes fund local, state and federal coffers, which are in turn drawn upon to pay for schools and roadway repairs, social services and national security. One of the contributing factors to the public's distrust of taxation is the amount of paperwork, details and bureaucracy that any American filing a tax return must endure throughout the process. Tax planning helps a taxpayer find his or her way through this maze of paperwork.
Indeed, there are a number of resources in use to help taxpayers prepare their annual reports to local, state and federal revenue agencies. By exploring these aspects of tax planning, the reader will better understand both the planning schemes and the environments of tax policy and reporting.
Very few industrialized countries operate without heavy reliance on tax revenues. Oman, for example, levies no income tax on its residents, but that revenue is compensated by a significant tax on businesses, particularly those in the oil industry. Without taxes, countries simply cannot operate unless an alternative form of revenue is located. Roads, education, social services, national security and other government operations depend on taxation.
While the value of tax revenues cannot be discounted, most people lament the taxes taken from personal income or which are assessed on the purchase of a candy bar. Indeed, taxes seem to be imposed on every aspect of life — income, business, home ownership, retail, lodging, restaurants, alcohol, fuel and personal property are among the various forms of taxation that is in place on the federal, state and local levels in the United States. Many other countries have a similar, diverse collection of taxes, often at even higher rates.
In light of the myriad of taxes that are prevalent in the U.S., reporting them to the federal and state governments is often an arduous affair for the uninitiated as well as those who understand it thoroughly. For this reason, a sizable percentage of the population turns to certified public accountants to assemble their returns. According to Harris Interactive, 47 percent of American men and 33 percent of women turn to computer software that helps them walk through each aspect of their returns step by step. The minority of people either prepare their taxes themselves, using paper forms, or turn to family members and friends to help file their taxes for them (Harris Interactive, 2006). While taxation is a fact of life for hardworking Americans, it is also a common fact that of the 91 percent of Americans paying their taxes, about 37 percent of them do not take steps to minimize their liability.
Reducing Tax Liability
Central to the issue of tax planning and preparation is the need for individuals to generate yearly tax reports that are accurate and incur the least amount of tax liability. Since people who earn more income pay more in taxes, the first way for individuals to reduce their tax liability is by reducing their income. Of course, they need not take a pay cut from their jobs in order to do so. Tax liability is determined by assessing the individual's Adjusted Gross Income (AGI), which is the aggregate of all income sources less any adjustments to income. If an individual, rather than applying all income to a deposit account, invests part of his or her income in a 401(k) or similar retirement account, that modification signals a reduction in taxable income. Similarly, a taxpayer who reports deductions to account for student loan payments, alimony or other expenses is also documenting an adjustment in income, thereby reducing tax liability (Perez, 2009).
Another important vehicle for reducing AGI is the deduction. There are a myriad of deductions an individual may report on his or her tax return, each of which must be itemized. In general terms, the IRS allows 11 types of deductions:
- Automobile registration fees,
- Real estate expenses,
- Charitable contributions,
- Investment expenses,
• Taxes,
- Casualty and theft losses,
- Job-related books and publications,
- Professional organization and government dues and fees,
- Education and research,
- Business use of an individual's home computer and Internet service, and
- Job search expenses (Robson, 2009).
In addition to deductions and adjustments, taxpayers may also see their tax liability decrease by taking advantage of available tax credits. There are a number of such credits, including incentives offered for a dependent's college education and another to encourage parents to adopt. For lower and middle income taxpayers, there is the Earned Income Tax Credit (EITC), which is designed to help those people who have full-time jobs but are not making very much in salary. The EITC helps qualified taxpayers reduce their tax liability and even see a refund despite receiving a relatively low paycheck (Internal Revenue Service, 2009).
Another vehicle for reduction of an individual taxpayer's tax liability is by increasing the withholding amount in that person's paycheck (Financial Web, 2009). Withholding is usually established when an individual begins his or her employment, but the modification can be made at any point thereafter. Increased withholding will result in a reduction in income but can also help generate a larger refund after April 15.
The greatest challenge for a taxpayer who is filing a return is to know about and take advantage of the myriad of vehicles that can help reduce tax liability by reducing one's AGI. This issue is the central point of tax planning — taxpayers would prefer to avoid losing tax refund monies by exploring every available resource.
Further Insights
Do It Yourself
Most people are not tax professionals. As such, the notion of filing an individual tax return that takes into account the extreme complexity of relevant tax laws is often intimidating. Then again, there are advantages that many Americans see to preparing their own tax returns. About 45 percent of Americans file their own taxes. The rationale is three-fold. First, many taxpayers see this avenue (as opposed to using an accountant or other tax service) as cost-effective. A tax preparation service may charge between $125 and $450 depending on the complexity of the return. These charges can negate a taxpayer's expected refund.
The second reason is a matter of convenience. An individual who files his or her own tax return does not need to set up an appointment, travel to a consultant's office and spend an hour or more either in a waiting room or at the accountant's desk while awaiting preparation. Instead, he or she may prepare the return at a time or place at his or her convenience.
Third, many consumers consider a tax return an important document that helps them understand their own finances. By becoming familiar with the myriad of deductions, adjustments and vehicles for AGI reduction, the taxpayer may better appreciate not only his or her tax liability but how he or she manages personal and business expenses.
Tax Software & E-Filing
Tax software became widely available in the 1990s and early 21st century, and has made personal tax filing even simpler for individual taxpayers and small business owners. A wide range of software systems have been introduced to the marketplace that enable the taxpayer to simply file on-line. All that individuals must do is either download the software from a company's website or visit one of many stores that sell such software. These programs are designed to help the taxpayer in every step of the return-development process, using clear and simple guidance language. This software is relatively inexpensive and, particularly for those whose income tax returns are simple. Business returns that involve a great deal of itemized deductions may prove frustratingly complex even with tax software.
An added benefit of electronic tax return filing (also called "e-filing") is the time involved between filing and receipt of the refund check. Whereas working with an accountant or simply sending in paper versions of the return may take weeks or more for processing, taxpayers who e-file may receive a refund check within 10 days (Wilburn, 2007). Furthermore, in light of the ongoing public concern of identity theft in the new global economy, taxpayers who e-file may take solace in the tight security this software provides them as they file their returns.
Those who are concerned with environmental protection also enjoy the fact that e-filing virtually eliminates the amount of paper involved with filing taxes. This fact has also taken root in state and federal revenue agencies, which have increasingly and actively encouraged taxpayers to use e-filing software to prepare and submit their returns. In 2004, for example, 4.2 million Californians e-filed their taxes three weeks before the April 15 deadline. In that state, e-filing increased 69 percent over the course of a year, causing a drop of 40 percent in the use of government paper. Additionally, the cost of processing paper returns in California was $1 — the lack of paper returns saved California's government millions of dollars ("State tax e-filing," 2004).
Thus, for a growing number of individuals, filing returns themselves has become more popular. However, there are still conditions in which help may be needed.
Getting Help with Tax Planning: CPA's
The common practice of filing one's own returns owes much of its momentum to the increased prevalence and user friendliness of online filing software. This has proven particularly useful for taxpayers with simple returns. However, there are situations in which taxpayer returns are considered better handled by a certified public accountant (CPA) or similar professional.
One benefit is the amount of experience a CPA brings to the tax planning process. While tax planning and return software is becoming more and more in tune with tax laws governing deductions and other aspects of AGI reduction, it is still a common perception that certified public accounts are more likely to find a higher number of tax breaks when performing a taxpayer's return. In fact, some studies indicate that CPAs are typically more aggressive in terms of locating relevant tax cuts for their clients than other tax preparers, such as lawyers (Dunn, 1986).
Another situation in which a certified public accountant often proves more useful is one of complexity. Indeed, the average taxpayer may have a relatively simple return to file — one that reports income, a few deductions and adjustments and perhaps income generated from market investments. However, in many cases, such as for businesses and multi-state returns, more complex filings are to be expected. Although such returns may be filed using "do it yourself" software, the intricacies of these types of returns may be too daunting for inexperienced taxpayers to perform by themselves. Those who do draft their returns in this arena are often well-advised to take the draft to a CPA to ensure that no mistakes were made and no deductions, tax breaks or adjustments were missed.
The familiarity of CPAs with the abundance of available tax deductions and adjustments helps the taxpayer particularly in cases when the return is being filed close to the deadline. Many taxpayers, private and business alike, do not review their tax information (including organizing receipts, reviewing the previous year's returns and researching updated benefits) until close to April 15. The short window they give themselves means that comprehensive reviews of such information may not be conducted in the interest of time. Small business-owners, for example, may miss important deductions on travel, meals and entertainment, which could help reduce significantly the amount of taxes actually owed (Lynott, 2006). While a last-minute return can cause hasty tax preparation, an accountant's familiarity and experience with both long-standing and new deductions may help the taxpayer craft a more accurate return.
Taxpayers who turn to CPAs place a great deal of trust in them. If a taxpayer files his own returns, he alone must assume responsibility for any mistakes on the documents. However, a CPA bears some responsibility for any return he prepares, and can be held accountable for any missteps and improper entries. The Internal Revenue Service carefully monitors the records of CPAs. If any CPA inserts erroneous data into a return, the IRS will often take pause to review not just that return, but any others that the accountant prepared as well. In fact, such reviews may include holding a taxpayer's refund check pending a review of the tax return (Boyles & Feldman, 1988).
The use of certified public accountants has developed into a matter of taxpayer preference. Until recently, CPAs and tax attorneys represented the dominant entity by which tax filings were prepared. Over the last two decades, the development of online software has led many to eschew the CPA and file without help. Then again, the CPA remains a valuable resource for those who have complex returns, who do not understand the intricacies of their personal income taxes and/or are constrained by the limits of the looming filing deadline.
Conclusions
In the 1980s, Congressional leaders pushed for a simplification of the US tax code. The system, proponents argued, was far too daunting for the average taxpayer to understand. A bipartisan compromise was ultimately reached by the mid-1980s, but not until after a long period of rancorous debate and sifting through countless proposals. One Congressman, Republican Delbert Latta of Ohio, took the floor and held aloft a thick document and said, "I hold in my hand 1,379 pages of tax simplification" (Anecdotage.com, 2009).
Naturally, the fact that taxation draws money away from an individual's regular income is the biggest reason why taxes are one of the most maligned aspects of life in the modern world, even though most people understand that taxes keep government and its services operating. Adding to the negative image people have of taxes is the fact that their application is usually complex, especially for the layman.
In order to protect his or her income, a taxpayer will usually seek to minimize the amount of taxable assets by reducing the elements that, in the aggregate, comprise his or her tax liability.
Each year, individuals who are planning their income tax returns will seek out the most effective ways by which they may reduce their adjusted gross incomes. In some cases, individuals may manage the planning and filing processes themselves, particularly if the returns are simple in nature. Such situations have been more common over the last few years, in light of new tax-planning software. Then again, the certified public accountant, long the authority in terms of knowledge of tax policy, remains relevant, particularly among those with complex returns or a lack of in-depth knowledge of the myriad of liability-reducing options. As this essay has demonstrated, consulting with an accountant or simply filing a return without help, as well as what options to apply on those returns, is a matter of individual choice.
Terms & Concepts
Adjusted Gross Income (AGI): The aggregate of all income sources less any adjustments to income such as deductions.
Earned Income Tax Credit (EITC): Helps qualified taxpayers reduce their tax liability and even see a refund despite receiving a relatively low paycheck.
E-Filing: A manner of filing an income tax return using computer software and e-mailing that return to the government.
Tax Liability: The amount of taxes for which a given individual or company is responsible.
Bibliography
Aalberts, R. J., Biggart, T. B., & Harden, J. (2013). Tax and Financial Planning for Same-Sex Couples in Light of Windsor. Journal of Financial Service Professionals, 67, 64-74. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89934875&site=ehost-live
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Harris Interactive, Inc. (2006, March 20). Two in five Americans filing taxes doing nothing to minimize tax liability. Retrieved September 2, 2009 from Market Research World. http://www.marketresearchworld.net/index.php?option=com%5fcontent&task=view&id=563&Itemid=77.
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Perez, W. (2009). Tax planning basics: 3 ways to reduce your taxes. Retrieved August 31, 2009 from http://taxes.about.com/od/taxplanning/a/taxplanning.htm.
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Suggested Reading
Blazek, J. (2004). Tax planning and compliance for tax-exempt organizations: Rules, checklists, procedures. Fourth edition [Book Review]. Chronicle of Philanthropy, 17, 64. Retrieved September 9, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=14982523&site=ehost-live.
Clements, J. (2004, April 14). Tax cuts aren't forever: four strategies to lower your tab in the years ahead. Wall Street Journal — Eastern Edition, 243.
Hoffman, E. (2004, November 1). Time to do your tax checkup. BusinessWeek, (3906), 110. Retrieved September 9, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=14797173&site=ehost-live.
Novack, J. (2005). Tax planning in the dark. Forbes, 176, 210-214. Retrieved September 9, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=19008747&site=ehost-live.
Raskolnikov, A. (2008). Relational tax planning under risk-based rules. University of Pennsylvania Law Review, 156, 1181-1262. Retrieved September 9, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=32667616&site=ehost-live.
Wiener, L. (1999). No vacation from taxes. US News and World Report, 127, 62. Retrieved September 9, 2009 from EBSCO Online Database Academic Search Complete. http://search.ebscohost.com/login.aspx?direct=true&db=a9h&AN=1995346&site=ehost-live.