Tax planning is taking the time to develop strategies to either reduce taxable income, take advantage of tax deferred, utilize lower tax brackets, capture all available credits, and minimizing additional taxes such as self-employment and alternative minimum tax. This is done through reading and understanding how to use the beneficial laws that are written into the tax code. Tax planning is intended to be a progressive tool that will aid business owners and individual taxpayers better manage their cashflow to meet the federal and state income tax burden. It is planning for the future rather than reacting to events in the past and therefore offers greater potential for significant savings.
Tax planning can be used to reduce taxable income. The Internal Revenue Code includes tax advantages such as accelerated depreciation, deductible employee benefits, health insurance plans that are funded pretax, converting non-deductible expenses into deductible expenses, investing in non-taxable assets, and offsetting taxable gains with unused tax losses that may be frozen in current investments. The benefit of this tool is that it reduces your current year’s taxable income without having to later recover the income.
Another option is taking advantage of tax deferred transactions. This strategy includes deferring revenue recognition through various accounting methods such as cash basis or completed contract, opening and utilizing qualified retirement accounts, and understanding the rule for how and when revenue must be recognized. It is important to understand that while this method can have substantial tax savings, eventually the income will be recognized and become taxable. You just control when that time occurs.
Taxpayers can also utilize lower tax brackets to reduce the amount of income tax they pay. This can be done through use of capital gains tax rates, reducing your current year Adjusted Gross Income to a lower bracket, or deferring revenue to avoid jumping into a higher tax bracket.
Capturing and taking advantage of all available tax credits is an essential tool of any good tax plan. Tax credits reduce a taxpayer’s income tax dollar-for-dollar as opposed to a normal deduction, which only reduces taxable income by the applicable income tax rate. The list of credits available and rules to be able to use them is voluminous and taxpayers often need the aid of tax practitioners to assist in this process. Additionally, tax credits are not only available at the federal level, but each State has its own set credits available to its residents that are used to reduce state income tax.
Finally, tax planning can help minimize other taxes such as self-employment or alternative minimum tax. Use of flow through entities such as S-corporations and Limited Liability Companies, if done properly, can significantly reduce the amount of self-employment income taxpayers have to recognize. Also, proper planning for net operating losses and converting certain itemized deductions into business deductions can help eliminate that pesky AMT Tax.
Tax planning is an essential tool to any business’ operating budget, but it does not have to stop there. Most taxpayers, whether you own a business or not, have the potential to take advantage of a well thought out tax plan to some degree. If you have questions about how you can implement a tax plan, please feel free to contact our office today.