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 about the concept of tax planning, including personal income tax and estate planning using legal means such as investment, estate planning, and retirement accounts.

Tax Planning Defined

You have a business venture and it is making money. Your accountant projects your income and the corresponding tax that you will have to pay. You are hesitant to shell out cash to pay your tax liability. So, you schedule a tax consultation with your accountant. The accountant can make suggestions on ways to legally reduce your expected tax liability. That is called 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 from a tax perspective with the end view of tax efficiency. However, tax planning should not be confused with tax avoidance as the latter includes ways to use tax laws that are not intended by Congress. On the other hand, when you use tax laws to reduce your tax payable in a legal manner that abides by the tax laws, it is referred to as tax planning.

Steps for Tax Planning

1. Start Early

Most people do their taxes in March or April when the deadline for filing tax returns is approaching. If you don't start making decisions that can reduce your tax bill until after December 31 or the year-end, you will be stuck with your current tax liability. Thus, it is highly encouraged that tax planning should start early to give you more time to make a good estimate of your investment gains or losses and income. The earlier you can get this information the more time you have to do something about it.

For example, you have an expected gain from an investment. This gain will put your total income within a higher tax bracket than the previous year, resulting in a higher tax. But, given that you have determined an estimate of your total income, you are able to plan out some deductions to put your income back into 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 in 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 for working toward a plan that results in savings. The amount of tax liability computed previously will allow you to determine how much to invest to save on tax.

3. Profile Risk Level

Since tax planning includes investment mechanisms designed to reduce your tax liability, it is important that you do 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

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

These characteristics must be assessed separately and 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 of income tax laws and their impact on how much you have to pay. Such an 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 or 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.

Tax planning on personal income taxes involves evaluation of the current taxes and income sources that can have an impact on your tax scenario. Other considerations include the taxpayer's residency, citizenship, personal cash flow, retirement plan, and charitable contributions.

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