Your Tax Planning Risk Tolerance Test
In a previous installment Tax Preparation vs. Tax Planning, we mentioned risk tolerance and the role it should play in selecting a tax planner. In short, you want to work with someone who views taxation in much the way you do and is willing to take as much, or as little, risk as you are comfortable with. Err on either end and you either wind up disappointed with your tax bill or sleepless at night—and neither is a good basis for financial happiness.
It can be difficult, however, to offer a prospective tax planner insight into your level of risk tolerance if tax strategy is an unfamiliar. Do not despair—we’re here to help!
Following is a brief tolerance test that will indicate your comfort with risk and rewards related to tax planning
Circle the answer that best describes you (circle only one per set)
How would you best define your feelings about your current tax liability?
- I pay low taxes and feel good about what I currently pay.
- I pay more than what I feel I should for my income and would like to pay a little less.
- I pay much more than I think I should and feel overtaxed. I need to pay less STAT!
- I pay a large amount in tax and it is a burden that keeps me from saving for retirement.
How would you describe your tax-related recordkeeping?
- I’m never sure what to keep, so I don’t maintain any records at all.
- I’m unsure of what to keep, but I try. I have some records.
- I’m pretty sure of what to keep and have a basic filing system.
- I’m very organized and have learned what to keep, so I have good records at tax time.
Tax-related communications with state or federal agencies (including IRS) are common. When you get letters from taxing authorities, how do you act and feel?
- I am terrified. I worry for days before I open the letter or I toss it in the trash without opening it.
- I am very concerned, open the envelope immediately, and read as fast as I can. Then I call my preparer to scream for help.
- I am curious and open the letter within a day. I respond or act if I can, but I don’t necessarily call my tax preparer.
- I’m relaxed and ready to respond. I open the letter and act on the instructions, calling my preparer if needed. I understand that taxing authorities are incorrect as often as anyone else.
How well do you understand our tiered federal income tax system?
- I don’t understand it at all. My tax situation is always a mystery.
- I understand the basics but don’t keep up with changes, so I’m often surprised.
- I understand the tax system well enough that I could do my own taxes in an online program.
- I understand taxes but choose to work with a planner to maximize my outcomes.
How have you handled tax preparation in the past?
- I do my own taxes or use a friend or family member.
- I choose a franchise service (H&R Block, Liberty, Jackson, etc.) based on the deals offered.
- I go to the same preparer annually, and they have my back.
- I invest in a CPA/EA and feel that you get what you pay for.
As you can probably tell, your total score in the above quiz will align with your tax risk tolerance.
A low score—mostly 1s in this questionnaire—means you have a low risk tolerance. You find tax issues intimidating and maybe even quiver when you think of the letters I – R – S. You’re most comfortable sticking to the straight and narrow, taking only those deductions that fall clearly within the “well tested” areas of the tax code. You’d prefer to take a hard pass on creative ways to apply legal deductions that could result in any questions from tax authorities.
A high score—mostly 4s—means you have a relatively high risk tolerance. We’re not saying you’re a budding tax evader! You believe in paying tax authorities their due, but you don’t want to leave a tip. You’re willing to take a chance on a legal but untested tax minimization strategy to realize additional savings. An IRS follow-up, such as a request for additional documentation, wouldn’t challenge your recordkeeping or your Zen mindset—you’d handle it yourself or call in the pros, no problem.
If you’re somewhere in between, well, you’re somewhere in between. You’ll leave it to others to push the boundaries of the tax code. But hey, if a particular deduction generally finds favor with tax authorities, you’re happy to avail yourself. You realize that seeking more deductions can invite more scrutiny, but as long as you’re on reasonable ground, you’re okay.
This test gives you a general idea of your risk tolerance, but there’s a better way to use it than merely tallying up your score. Take it with you to your tax planning appointment and discuss each area with your advisor.
Our risk “settings” aren’t always set in stone. A great tax advisor may be able to increase your tax knowledge or advise on a record-keeping system that will increase your comfort level and expand your tax strategy options. But you’ll never know unless you ask!
Need help building a financial management team? We invite you to visit www.scfinancialservices.com for an overview of our comprehensive financial management programs. And yes, we recommend tax planners as part of our system!