How Tax Planning Differs from Tax Compliance
If you want to be healthy, you must eat your vegetables. It is a tale as old as time. Tax compliance and brussels sprouts are alike in that way. They are necessary, but not very exciting. What if I were to offer you a side of brussels sprouts stuffed with mozzarella cheese and pepperoni? Sounds much more appetizing, right? In this article, I’m going to show you how multiyear tax planning is the mozzarella cheese and pepperoni to an otherwise plain bite of brussels sprouts.
Most CPAs tend to focus solely on tax compliance
Tax compliance is necessary, like water. You must do it or else you will find yourself experiencing major consequences. Every tax season, we scramble to make sure that we have properly captured all of our documents, reporting what we need to report and having the right forms going to the right place at the right time. We delegate to Certified Public Accountants (CPAs) or other tax professionals because tax regulations change constantly and are outside of our expertise.
CPAs help to organize books and records each year, keep them compliant and help avoid costly mistakes. We tend to be satisfied with this exchange, because it is necessary, and it protects us. However, there is a lingering frustration for most entrepreneurs that more can be done with their taxes. Each year during tax time, that frustration is lit right back up as time is spent organizing all the documents to be sent, and then waiting for the “number” the CPA will soon report. If taxes are gray, why does it often feel like there is a black and white tax strategy with tax professionals?
Well, if we look at the breakdown of United States households, the reason most CPAs focus on annual tax compliance versus tax planning makes a great deal of sense. In the US, 91% of workers derive most of their wages from employers, independent contractor income and benefit packages each tax year. A typical CPA will work to mitigate a total tax bill through standard strategies like using qualified retirement plans, Health Savings Accounts (HSAs) and tax qualified college savings programs. In other words, paying the bottom line for what is owed but working around the edges to get the “best deal” possible. If you fall within the 9% minority of workers who derive most of their income as business owners, you can see why it may be difficult to find a CPA equipped to work with your unique tax situation.
How tax planning differs from tax compliance
As an entrepreneur, the tax decisions you make can be broad and long term. When you extend beyond tax compliance and begin thinking about tax planning, the focus is on the big picture over the next several years. It is also on your ultimate plan for business equity. How much income do you want to recognize this year? What does your equity management strategy look like over the next decade? Should you consider bumping up purchases of Section 179 eligible business expenses into the end of this year, or keep them on schedule to the following year? What about starting your next venture as a C corporation or a limited liability company (LLC)?
As a business owner, you get to control the taxable outcomes that your business creates. As you are operating your business from year to year, I encourage you to be mindful of incorporating longer term projections into the planning process. The right CPA will help you generate a range of multiyear business financial projections and model various tax scenarios based on them. Looking at least three years into the future allows you to execute strategies today that can drastically change your tax picture down the road. Ideally, this planning process begins as you are starting your company, because selecting the entity structure and how you fund startup costs are key elements for your tax strategy.
Most entrepreneurs have never heard of QSBS
One of the most underappreciated provisions in the current US tax code is the ability to use Qualified Small Business Stock (QSBS) under Section 1202 of the Internal Revenue code to exclude a portion or potentially all of the capital gains resulting from the sale of their C corporation stock. Without delving into all the mechanics of QSBS, this provision allows for qualified business owners to exclude $10M or 10 times their basis in qualifying stock from capital gains tax. Most entrepreneurs have no idea this provision exists or how to incorporate it into planning for their startup. Without the right wealth management team and CPA who is well versed in the tax planning process, many business owners end up missing out on this great opportunity.
Tax planning is more impactful with your exit strategy in mind
Perhaps the areas of greatest impact for tax planning are your business equity and exit strategies. When do you intend to sell some or all of your equity? To whom? What do you envision the transaction looking like? If your strategy is to gradually sell equity to a successor owner group over the next five years, you might consider executing within a series of financed transactions. This scenario can create a far different tax outcome when compared to selling 100% to an external buyer three years from now. There may be elements of structuring your business or the transaction that can be done today to improve the outcome when the transaction occurs. The earlier you can start those conversations with the right planning-centric CPA team, the more value they will be able to add to your exit process down the road.
How to find the right CPA for your tax planning needs
Not all CPAs offer tax planning or have the proper skill set to offer great advice. However, it never hurts to ask! You might be surprised. Here are a few prompts I would suggest starting off with:
- When can we get together for a multiyear tax planning analysis?
- I would like to walk you through my business strategy and see if there are any opportunities to change or do things differently.
- How do your tax planning and tax compliance processes differ?
If your CPA gives you a “deer in the headlights” look when asking these questions, they are probably not the right fit for your tax planning needs. Finding the right CPA for your needs involves having a thoughtful vetting process. Start by asking around within your network of peers, business owner organizations, mastermind, and industry groups. Look for entrepreneurs like you, within a similar industry, who are growing and building businesses and find out how they approach tax planning with their CPAs.
A good, planning-focused CPA should be able to tell you about the types of clients they work with and provide various case studies that demonstrate the value that they have been able to provide to clients like you. They will walk you through their process and explain how they can make time throughout the year for the planning process beyond the tax filing season. Here are a few additional vetting questions I always recommend asking a potential CPA:
- What is your philosophy and process around multiyear tax planning?
- How do you incorporate future equity plans or business exit planning in my day-to-day tax planning and tax compliance work?
- Who is your average client, and what kinds of knowledge and expertise do you have to be able to serve those clients?
- Who don’t you work well with?
I especially love the last question above because you tend to throw people off and get a lot of great answers in return. A great planning-centric CPA will scope out your project, looking into the last two to three years of your tax returns, and conduct a thorough analysis. As a bonus, if you have not had great tax planning before, they may even identify opportunities that warrant an amendment or refile on one or more of your previous tax years.
Tax planning is a process, not an event
When done correctly, tax planning is something that is incorporated into your business management cadence throughout the entire year. Tax laws change, and new provisions are enacted all the time. Having a CPA that is well versed in both compliance and multiyear planning is key. So, what are you waiting for? Go forward and find the best-tasting mozzarella and pepperoni for your brussels sprouts and have fun exploring all the possibilities that come with multiyear tax planning for your small business.
If you have a question or simply want to talk through your financial planning, we are here to help.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy. Advisory services provided by Destiny Capital Corporation, a Registered Investment Adviser.
ABOUT JARROD
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.