3 Levels of Tax Work: Tax Strategy, Tax Planning, Tax Compliance


This post is in: Business, Real Estate
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I’m known for one answer to most questions, “It depends.” When it comes to taxes, the answer really does change based on your personal circumstances and the current tax law and climate. It can be frustrating for taxpayers who attempt to go the “do it yourself” route.

Let’s start with a few common myths about the IRS.

Myth: The best source of IRS compliance information is the IRS.
Fact: The Treasury Dept’s regular test of advise given by IRS agents showed 35% of the advise was just plain wrong. And if you had relied on it, you would have to pay tax, penalties and interest. There is no recourse.

Myth: The IRS booklets will tell you everything you need to know about filling out your tax return. Fact: Well, this one is partially right. If you have a very simple Form 1040, you can probably find everything you need in the detailed instructions. But if there has been a recent law change or the circumstances are any different from the straight and narrow, you can’t find the answer in the instructions. Plus, it’s likely the instructions will use terms that you need to consult Rev. Rulings, Rev Procedures, Treasury Regs and/or case law to clearly define anyway.

Tax law is complicated. And it’s frequently changing. I worry about archiving my blog posts because I’m afraid someone will go back and read something about tax credits, home office, principal residence exclusion or NOL from just a few months ago and take what I wrote as the truth for today. It might be true, or in the cases above, it very well might not be. Law is constantly changing.

The other issue is that there really are three approaches to your taxes.

Level One: Tax Compliance. This is the most basic level. Even the most sophisticated tax strategy needs tax compliance, but if you’re working with a high level strategy your approach to compliance is different than someone who is just filling out their tax return.

In most cases, a do it yourselfer can find all the information that he needs in the instruction booklet. The problem, of course, is if he reads about a cool tax strategy here and on the tax forum and decides to try a more sophisticated approach…by himself. He can’t find where it says in the instruction book how to report something and then gets frustrated.

That’s because he’s trying to use a Level Two or Three technique with Level One ability. Not that there’s anything wrong with doing it yourself, but unless you’re a seasoned professional you’re going to have problems with how to be in compliance.

Level Two: Tax Planning. Tax planning is a step up from just compliance. That usually happens in the last few months of the calendar year. And that’s where you’re looking at when to make purchases, how to handle end of the year transactions, inventory purchases and maybe even how and when to put something in service to claim a year’s worth of expenses. Tax planning is a higher level then just filling out a tax return. But just like with Level Three: Tax Strategy, tax planning is worthless without tax compliance that follows through to make sure the right things are reported in the right place.

Level Three: Tax Strategy. Now this is my favorite part! Here is where we look at your business and see where the income possibilities are and how we can turn those into great tax saving possibilities as well. For example, how can we accelerate and leverage what you already do to create multiple streams of passive income? It’ll be taxed at a lower rate and give you the opportunity to make money even when you’re not working.

How about setting up investments so that you NEVER pay tax? Or turning more of the expenses you have now into legitimate business deductions? This is where you get to take advantage of the new 2008 NOL rules for carryback losses on short sales or value declines to push losses into 2008 and never pay tax on debt forgiveness (if you have it).

And, yes, with Level Three you still need year-end tax planning and you still need solid tax compliance. But, trust me, at this level you’ll never find the answers in the instruction book. You are relying on interpretation of case law, regs, procedures and rulings. And you disclose your reliance to get the SOL running.

I could write, and talk, for hours about these sophisticated strategies that we’ve been handed by the new administration and I know, just as sure as I do, that someone is going to demand that I show them where exactly it says you can do that. My answer will be, “Show me where you can’t.”

Are these loopholes going to be around forever? Of course not, I suspect in 5 years or less we’ll hear about Congress meeting quickly to close these tax advantages that business was suddenly handed. And that means for all my clients that have saved hundreds of thousands of dollars, that they won’t be there anymore.

Will we look with longing back at these times? Heck no. That’s because there will be brand new strategies.

And that’s what it means to have a strategy…and not just planning or compliance.



One Comment

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