Never fall into the misconception that tax planning is only for wealthy individuals and owners of mega-successful businesses. Tax planning can benefit any person that wants to increase their income by minimizing their tax liability. Whether you are a U.S. resident or citizen, U.S. expatriate, or the owner of an international business, tax planning will likely benefit you or your business in more ways than one.
Certified public accountant and founder of US Tax Help Ted Kleinman provides tax planning services for US residents, US expatriates (expats) and foreign nationals. Ted has served clients in Bermuda, the Cayman Islands, Belgium, Canada, Australia, and several other countries. With over 30 years in personal and business income tax, CPA Ted Kleinman would be proud to help you with your unique tax planning needs. To schedule a consultation, call US Tax Help at (541) 362-9127, or contact us online.
- What is Tax Planning?
Tax planning refers to financial planning for tax efficiency. It aims to reduce one’s tax liabilities and optimally utilize tax exemptions, tax rebates, and benefits as much as possible. Tax planning includes making financial and business decisions to minimize the incidence of tax. This helps you legitimately avail the maximum benefit by using all beneficial provisions under tax laws. It enables one to think of their finances and taxes at the beginning of the fiscal year, instead of leaving it to the eleventh hour.
Table Of Content
- What is Tax Planning? Understanding Tax Planning
- Why should you do Tax Planning?
- Goals of Tax Planning
- Three Types of tax planning
- Advantages of tax planning
- Tax Planning vs. Tax Gain-Loss Harvesting
Understanding Tax Planning
Tax planning covers several considerations. Considerations include timing of income, size, and timing of purchases, and planning for other expenditures. Also, the selection of investments and types of retirement plans must complement the tax filing status and deductions to create the best possible outcome.
Why should you do Tax Planning?
There are some fundamental objectives of tax planning. Tax planning diminishes tax liability by saving the Assets he maximum amount of tax by arranging their financial operations according to tax decisions. It also conforms to the provisions under taxation laws, thereby minimizing any litigation. One of the biggest benefits of tax planning is that the returns can be directed to investments. It is the most productive way to make smart investments while fully utilizing the resources available due to tax benefits. Investing tax money generates white money to flow through the economy, aiding in the country's economic development. Tax planning hence contributes to the economic stability of the individual as well as the country.
Goals of Tax Planning
As mentioned above, the primary goal of tax planning is to minimize the effect of taxes on your income. There are several methods that you can use to accomplish this task. The following is a list of tax planning methods that can help you reduce your tax liability.
- Utilize Your Tax Credits
A tax credit is a certain amount of money that can be used to offset tax liability. Tax credits are different from deductible expenses because deductibles reduce taxable income, but they correlate with the taxpayer’s marginal tax rate that may increase or decrease depending on their income. Tax credits decrease taxes without taking tax rates into account.
You can use tax credits for college expenses, retirement savings, and even for the adoption of children. One of the most commonly used tax credits is the earned income credit (EIC). The EIC is popular because it can be credited to an account like a payment, kind of like a tax refund.
According to the IRS, if you paid taxes or accumulated taxes to a foreign country or U.S. possession and you are still subject to U.S. taxes, you may be entitled to a foreign tax credit. Typically, only war profits, income, and excess profits taxes may qualify for a foreign tax credit. Additionally, if you have an unused tax credit, it may be possible to use those credits in future tax years for up to five years.
- Decreasing Your Income
One important factor that you need to keep track of when planning your taxes is your adjusted gross income (AGI). Your AGI has an impact on your tax rate, your access to certain tax credits, and various other tax issues. The IRS defines AGI as your gross income minus any adjustments to your income. Your AGI will increase when your income increases and this will require you to contribute more money to taxes.
One way to reduce your AGI is by contributing money to a workplace retirement plan like a 401(k). Your contributions to the retirement plan will reduce your wages and subsequently reduce your tax bill. While this method is not applicable to every individual, US Tax Help can personally work with you to discover a plan that is unique to your particular situation.
- Take Advantage of Your Tax Deductions
Tax deductions are another important part of tax planning. A deductible is an expense that can be subtracted from taxable income. Almost every person has at least one deductible expense, and if you are the owner of a corporation or other entity, you likely have several deductible expenses.
A deductible expense can be any of the following:
- Health care expenses
- State and local taxes
- Mortgage interest
- Donations to charity
- Job-related expenses from an employee and employer viewpoint
- Investment-related expenses
If you are a U.S. expat, you may have access to other deductions and exemptions that are not listed above. For example, under certain circumstances, an expat can be eligible for the foreign earned income exclusion. if you qualify, you can exclude up to $105,900 in 2019. The money used for this exclusion can be earned from a U.S. employer, a U.S. corporation that you own, a foreign employer, or an offshore corporation that you own. It is important to note that if you earned your wages or salary from a U.S. company, you and the employer are subject to payroll taxes. However, if the wages are received from a foreign corporation, you can be exempt from payroll taxes under certain circumstances.
Another deduction that is available for an expat is a foreign housing deduction. To qualify for this deduction, you must be a self employed individual, a wage earner, or a salaried employee. This deduction can be claimed in addition to the foreign earned income exclusion and will increase your exempted income depending on how much of your housing expenses are deductible.
Three Types of tax planning
- 1. Purposive tax planning
- 2. Permissive tax planning
- 3. Long range and Short range tax planning
- Purposive tax planning
Purposive tax planning means applying tax provisions in an intellectual manner so to avail the tax benefits based on national priorities. It includes tax planning with a purpose of getting the maximum benefit by making suitable program for replacement of assets, correct selection of investment, varying the residential status and diversifying business activities and income.
Also, Under Income Tax Act, Section 60 to Section 65 is related to the income of other persons included in the income of assesse. Here, assesse can plan in a way that the provisions do not get attracted so as to increase the disposable resources. This is known as purposive tax planning.
- Permissive tax planning:
Long range and Short range tax planning: Short-range planning means planning made annually to fulfill the limited or specific objectives. It is executed at the end of the year to reduce taxable income legally. Also, in short-range tax planning there is no permanent commitment. An individual may invest in NSCs (National savings certificate) or PPF (Public Provident Fund) within the prescribed limit when income is increased. It is not advisable to take LIC/ULIP/Pension Plan etc.
Long range tax planning refers to the practices undertaken by the assesse. Long term planning is done at the beginning or the income year to be followed around the year. Long term planning does not help immediately, for example transfer of assets without consideration to minor child. In this case, the income will be combined to transfer up to the child in minor but once the child turns 18, this will be the child’s income.
Advantages of tax planning
- To minimize litigation: To litigate is to resolve tax disputes with local, federal, state, or foreign tax authorities. There is often friction between tax collectors and taxpayers as the former attempts to extract the maximum amount possible while the latter desires to keep their tax liability to a minimum. Minimizing litigation saves the taxpayer from legal liabilities.
- To reduce tax liabilities: Every taxpayer wishes to reduce their tax burden and save money for their future. You can reduce your payable tax by arranging your investments within the various benefits offered under the Income Tax Act, 1961. The Act offers many tax planning investment schemes that can significantly reduce your tax liability.
- To ensure economic stability: Taxpayers’ money is devoted to the betterment of the country. Effective tax planning and management provide a healthy inflow of white money that results in the sound progress of the economy. This benefits both the citizens and the economy.
- To leverage productivity: One of the core tax planning objectives is channelizing funds from taxable sources to different income-generating plans. This ensures optimal utilization of funds for productive causes.
Tax Planning vs. Tax Gain-Loss Harvesting
Tax gain-loss harvesting is another form of tax planning or management relating to investments. It is helpful because it can use a portfolio's losses to offset overall capital gains. According to the IRS, short and long-term capital losses must first be used to offset capital gains of the same type. In other words, long-term losses offset long-term gains before offsetting short-term gains. Short-term capital gains, or earnings from assets owned for less than one year, are taxed at ordinary income rates.