October 30, 2020

Puzzle Out Tax Planning – A Beginners Guide to Tax Strategies

cathy pham 3jAN9InapQI unsplash

cathy pham 3jAN9InapQI unsplash

In today’s complex nexus and dynamic tax environment, every individual, investor, and business needs knowledge of Tax Planning and Compliance, which can reduce or limit future liabilities.

Tax planning is a process to examine financial planning from the perspective of tax. The main motive of tax planning is to ensure tax efficiency. By doing tax planning, one can make sure that all the components of a financial plan can be put together with maximum efficiency. Increasing the contributions and reducing the liability of tax towards the retirement plans are very important and critical for success.

Meaning and Goal Of Tax Planning

Tax planning plays a vital role in the story of every person’s financial growth as payments regarding tax are compulsory for all individuals who fall under the bracket of IT. By tax planning, one will be capable of trimming down her/his tax payments so that she or he will receive considerably fair returns over a particular period with minimum risk involved. 

·         Classification:

Permissive: Tax planning which comes under the body of law

Purposive: Tax planning that is done with a specific objective

Long term and Short term: Tax planning is done in the beginning and following the end of the fiscal year

·         Strategy or plan of action:

Income earned by hard work gets deducted in the form of tax in many ways, like state and federal levels, by Medicare and social security, etc. These taxes are hard to avoid, but there are still many ways and tax strategies that help to wave them off.

·         Selection of Entity: 

The selection of the form of entity has a significant impact on the rate at which tax liability accrues. Some of these forms are:

·         Sole Proprietorship: 

These are small businesses, and the owner files return for their business with the IRS (Internal Revenue Services). There is no other tax that is imposed except for the self-employment tax. All self-employed persons pay a portion of the FICA tax (15.3 percent) for both the employer and employee.

·         Partnership:

At the end of the tax year, partnerships file for the information form (Partnership Statement of Income) with the IRS and inform each partner about the accrued income. Income division depends on the nature of the agreement. It becomes possible to pass new partnership losses to one partner to maximize their tax profit or advantage.

·         Decreasing Income:

One important thing that needs to keep track while planning your taxes is to adjust gross income (AGI). As AGI influence tax rate, accessing the certain tax credits and many other tax problems. 

·         Investment in Municipal Bond:

Tax-free payment of interest is the reason which makes it attractive. Investment by buying municipal bonds means lending money to local or state bodies for a particular number of payments for a set period. 

Finally, when the bond’s maturity date comes, the full amount of original payment is paid back to the buyer. These bonds are exempted from federal taxes and may be exempted at the local and state levels.

·         Investment In Treasury Bonds:

Treasure Bonds and saving bonds also play an important role in tax efficiency as they are exempt from local and state income taxes. On the other hand, corporate bonds do not have any tax-free or tax advantage provision.

·         Select Deductions Intelligently:

Under TCJA, the standard deduction was increased, and some other deductions got eliminated. At the same time, this affects some items on a tax return like local and state tax deductions, mortgage interest, medical expenses, charitable contributions, home equity loan interest, and alimony. The financial situation specifies which deductions will be applied.

·         Itemizing Tax Return:

Tax strategies make itemizing more attractive. For example, if you own a house itemizing the deductions for property tax and mortgage interest may add to more than the standard deduction, which saves a lot of money. Even if you took the standard deduction on behalf of federal return, there is still a chance itemize on the sales tax return.

·         Go through the RMDs:

Investors need to understand and recognize their RMDs (required minimum distributions) who have money in tax-deferred retirement accounts like established IRAs and other eligible retirement arrangements and plans. These amounts, which must be withdrawn annually, then become part of your taxable income. This amount must be pulled out annually, and then it becomes the part of taxable income.

·         Tax Incentives and Credits:

Numerous state and local bodies offer incentives to attract and approach new and upcoming businesses and enlarge existing ones. 

Example:

·         Adoption credit

·         American opportunity credit

·         Charitable contribution

·         Capital loss deduction

·         Residential energy tax credit

·         Credit for the elderly or disabled

·         Lifetime learning credit

·         Saver’s credit 

So, know how prime tax planning or tax strategy works and take these steps to shrink your tax liabilities.