Tax Planning: Strategies & Steps

Instructor: Shelumiel Ryan Abapo

Shelu is a Certified Public Accountant, SAP Business One Consultant, University Professor handling Taxation, Financial Accounting, Cost Accounting and Basic Accounting

In this lesson, you will learn the steps for tax planning and understanding personal income taxes, estate planning, small business, self-employment taxes, and Individual Retirement Account (IRA) in the context of tax planning.

Tax Planning Defined

You had a business venture and it is making money. Your accountant projected your income and the corresponding tax that you will have to pay.

Obviously, you were hesitant to shell out cash to pay your tax liability. So you consulted with your accountant.

The accountant would then make suggestions on ways to legally reduce your expected tax liability. That is basically tax planning.

Tax planning is commonly defined as the manner of forecasting your tax liability and creating circumstances and ways to reduce it. Tax planning involves the analysis of your financial situation in a tax perspective with the end view of tax efficiency.

However, tax planning should not be confused with tax avoidance as the latter includes forms which use tax laws in ways not intended by Congress. On the other hand, when you use tax laws to reduce your tax payable in any manner contemplated by the government, it is referred to as tax planning.

Steps for Tax Planning

1. Start Early

Most people would only do their taxes in March or April when the deadline for settling tax returns is fast approaching. As such, when you start making decisions that would reduce your tax bill after December 30 or the year end, you will most likely be stuck with whatever numbers you got on hand.

Thus, it is highly encouraged that tax planning should start earlier to give you more time to make a good estimate on your investment gains or losses and income. The earlier you can get this information means more time for you to do something about it.

Example, you have an expected gain from an investment. This gain would put your total income within a higher tax bracket than the previous year, resulting to a higher tax.

But given that you have determined an estimate of your total income, you were able to plan out some deductions to put back your income to a lower threshold.

2. Assess Tax Liability

Tax liability is the amount of tax payable based on current and applicable tax laws. An event or transaction that results to a tax consequence triggers the calculation of the tax liability.

The calculation is done by multiplying the applicable tax rate on your determined tax base. The tax base could either be your income or asset balance during the period. The resulting product will be your taxable amount for the tax period.

Having a certain estimate of your tax payable is helpful in working a plan that works towards savings. The amount of tax liability computed previously would allow you to determine how much to invest to save tax.

3. Profile Risk Level

Since tax planning would include investment mechanisms designed to reduce you tax liability, it is important that you do a risk profiling. It is a process of finding an optimal level of investment risk that your current financial situation and other personal circumstances may permit.

To come up with a risk profile, you need to consider the following:

a. Risk Required: the risk associated with the return you want to achieve;

b. Risk Capacity: the level of risk that you can afford to take; and

c. Risk Tolerance: the risk level that you are comfortable with.

These characteristics must be assessed separately and thereafter compared to one another to come up with a trade-off decision to achieve optimum results.

Personal Income Tax Planning

It is crucial in tax planning that you to get a good grasp on income tax laws and their impact on how much you have to pay the government. Such understanding allows you to make strategic planning options with the purpose of preserving more wealth.

Personal income tax is a direct tax levied on your earned income either from employment or owning a business. A person could be an individual, ordinary partnership, non-juridical entity and undivided estate. As a general requirement, an individual has to compute his tax liability, file his tax return and pay tax on a calendar basis, a period beginning January 1 and ending on December 31.

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