What is tax planning explain the importance of tax planning?
What is Tax Planning?
Tax planning is a way to find out how much money you are paying on tax and also a way to help minimise the tax liability (the amount owed to tax authorities) through the use of allowances, deductions, exclusions and exemptions. Tax planning can be used in a number of ways; for example for retirement, businesses, Wills, and properties.
How It Works
When you start tax planning, you can find many guides online and you can also speak to financial advisors and solicitors to help get you started and give you all the important information that you will need to know. For example, each person has an inheritance tax allowance up to £325,000 with anything over the threshold being charged at 40%. So, if an estate was valued at £400,000, only £75,000 of that would be taxed. Since the majority of people won’t leave an estate over this amount, most feel they don’t need to know about inheritance tax. However, actively considering it and your future can help you to avoid any nasty surprises later on.
Helpful for Businesses
There are different types of taxes which can be hard to keep up with especially if you own a business. Tax planning is important for both small and large businesses because it can help them to achieve their business goals. When you have a tax plan as the owner of a business, you can lower the amount of taxable income, gain more control of when taxes are paid and also reduce the rate of tax. Depending on the type of business you have, you can find many different benefits. For example, if you have a business that is international, you can manage the timing of tax bills and can avoid double taxation.
Understanding Tax Planning
Tax planning plays an important role in the financial growth story of every individual as tax payments are compulsory for all individuals who fall under the IT bracket. With tax planning, one will be able to streamline his/her tax payments such that he or she will receive considerable returns over a specific period of time involving minimum risk. Also, effective tax planning will help in reducing a person’s tax liability.
Tax planning can be classified into the following:
- Permissive tax planning: Tax planning which falls under the framework of the law.
- Purposive tax planning: Tax planning with a specific objective.
- Long-range/short-range tax planning: Planning executed at the beginning and towards the end of the fiscal year.
Why Is Tax Planning Important?
Tax planning is an integrated course that allows you to combine various activities to come up with tax-effective solutions. When using tax planning to minimise the stress of tax, a tax planner will work with you to ensure the process is as simple as possible. Here are some of the ways a professional tax planner will help you:
Tax planning objectives
The main objectives of tax planning are as follows:
- REDUCTION OF TAX LIABILITY
The government’s objective is to maximise the tax deposited by the citizens. Authorities often come up with legal ways to ensure that you pay the maximum tax possible. But there are ways to save yourself money while remaining ethical and within legal boundaries. To do so, you should try to find a break route between the probable transactions and the analysed tax applicable.
Tax planning can be used to ensure that funds from taxable sources are diverted to income-generating plans. The main aim is to use productive investment planning to come up with the most beneficial tax saving options.
- MINIMAL LITIGATION
You never want to face legal litigations in your attempt at reducing your tax burden. Tax planning comes in to ensure that precautions are taken to avoid any possibility of litigation afterwards.
- GROWTH WITH THE ECONOMY
A business can grow with the economy so long as the right measures to ensure finance growth are taken. Generally, the tax planner should make the effort of ensuring that one’s business money takes the right direction for circulation.
- ECONOMIC STABILITY
The economic stability of a nation benefits everyone, including the taxpayer. Tax planning ensures that all legally-due taxes are paid on time. This is how a productive economy is created.
The Importance of Year-Round Tax Planning
You did it! You successfully turned in your tax return by this year’s deadline. That means there’s no need to think about taxes for another year, right? In fact, the California Society of CPAs advises that there are many smart and easy steps you can take now that will potentially improve your financial situation today and at tax time next year.
Turn to the Return
Although you may be happy to be done with it, the tax return you just completed contains a wealth of clues about your financial situation and opportunities to make it better. Your CPA can help you make sense of what it has to say, but it’s a good idea to review it thoroughly before speaking with a CPA, so you’re well versed on the facts.
Providing for College Education
At the beginning of your return you are asked to list your dependents. If you have children and college education costs are an issue, there are a number of tax benefits you may be able to use, such as the American Opportunity Credit, which allows qualified taxpayers to reduce their taxes by as much as $2,500 a year.
If you’re saving for future tuition expenses, a Section 529 plan investment account allows your savings to grow tax-free and distributions from the account are tax-free—to the beneficiary—to the extent they are used to pay qualified college costs. If you’re not making the most of some of the many chances to minimize your family’s education expenses, it could be costing you money.
Your tax return’s Schedule A lists the deductions you took last year. Taxpayers who are subject to the alternative minimum tax (AMT) may lose the benefit of some of their deductions. If that’s the case, it may be a good idea to accelerate or delay some income or deductions wherever possible to avoid triggering the AMT. Your CPA can help you understand how to decide.
If you own a home and your return shows a large deduction for home mortgage interest, it may be advisable to consider refinancing to get a lower interest rate. While deductions are always welcome, it’s better to lower your financing costs and keep that interest money in your own pocket.
If you haven’t been making contributions to a tax-advantaged retirement plan, then you’re missing a great opportunity to get ahead. With a 401(k), 403(b) or other employer-sponsored plan, you can contribute pre-tax earnings that can grow tax free over time. Those who don’t have access to such plans may be able to take a deduction for their contributions to individual retirement accounts (IRAs), simplified employee pensions (SEPs) or other similar plans.
In addition to the tax benefits, saving slowly for retirement over time is simply a smart way to ensure that there will be a nice nest egg waiting for you later. Even if you can’t make the maximum contribution, CPAs advise putting away as much as possible toward retirement because of the many benefits involved.
Estate Planning Options
There have been many changes in the laws governing estate taxes in recent years, which means it can be hard to predict who will be subject to them down the road. Proper estate planning can help lower estate taxes and accomplish a range of other goals. Your CPA can offer more details on the best ways to provide for your family’s future.
Characteristics of an Effective Tax System
- Fairness, or equity, means that everybody should pay a fair share of taxes. There are two important concepts of equity: horizontal equity and vertical equity.
- Horizontal equity means that taxpayers in similar financial condition should pay similar amounts in taxes.
- Vertical equity is just as important, however. Vertical equity means that taxpayers who are better off should pay at least the same proportion of income in taxes as those who are less well off. Vertical equity involves classifying taxes as regressive, proportional, or progressive.
While no system of taxes is perfect, it is important to seek horizontal equity because taxpayers must believe they are treated equally. It is just as important to seek vertical equity so government does not become a burden to low-income residents.
- Adequacy means that taxes must provide enough revenue to meet the basic needs of society. A tax system meets the test of adequacy if it provides enough revenue to meet the demand for public services, if revenue growth each year is enough to fund
A self-balancing accounting structure with revenues, expenditures, assets and liabilities used to track monies flowing…
the growth in cost of services, and if there is enough economic activity of the type being taxed so rates can be kept relatively low.
- Simplicity means that taxpayers can avoid a maze of taxes, forms and filing requirements. A simpler tax system helps taxpayers better understand the system and reduces the costs of compliance.
- Transparency means that taxpayers and leaders can easily find information about the tax system and how tax money is used. With a transparent tax system, we know who is being taxed, how much they are paying, and what is being done with the money. We also can find out who (in broad terms) pays the tax and who benefits from tax exemptions, deductions, and credits.
- Administrative ease means that the tax system is not too complicated or costly for either taxpayers or tax collectors. Rules are well known and fairly simple; forms are not too complicated; the state can tell if taxes are paid on time and correctly, and the state can conduct audits in a fair and efficient manner. The cost of collecting a tax should be very small in relation to the amount collected.