Tax planning is part of financial planning and there are no two ways to do it. The major problem, for most people, is that they tend to treat tax planning as an afterthought.
If you treat your taxes like an afterthought, something to look at later on, then the tax that you are supposed to be prepared for will treat you like n afterthought as well. When taxes do you a number, they sure do you one heavy.
It is in not planning one’s self properly that one ends up taking foolish advice that ends up with them spending twice the normal amount that should have left their pockets if they had just planned.
This article discusses the concept behind tax planning, the importance of planning your taxes and why not planning could be a really bad idea.
What is taxation?
Taxation is based on the idea of shared collective responsibility, which means that all members of a community are accountable for the well-being of the entire society, not just their own.
This represents the fact that as a member of a society, you gain a substantial amount of benefit from it. The implementation of these benefits is costly. The only option for the organization to cover these costs is for its members to pay a tax.
Tariffs, income or consumption taxes, or even user fees are all terms used to describe these levies. Regardless, they’re all taxes.
In some cultures, you can pay taxes solely with money; in others, you can pay a portion (or all) of your taxes with products or services.
Taxation differs from other types of payment, such as market traders, in that it does not require agreement and is unrelated to the services provided. The government uses an implied or explicit threat of force to coerce taxes.
Tax systems have evolved greatly throughout time and between nations. Taxation is imposed on both tangible assets such as property and particular events such as sales transactions in most modern systems.
What is planning?
Planning is the most basic managerial job mostly because you have to manage yourself well before you manage others, and it entails choosing ahead of time what needs to be done when it needs to be done, how it should be done, and who will do it.
It is an intellectual process that establishes a person’s or an organization’s objectives and determines potential courses of action for achieving those objectives. It lays strategic step-by-step instructions for achieving a certain objective.
We must plan since the future is exceedingly uncertain, and no one can accurately foresee the future because conditions might alter at any time. As a result, planning is a fundamental prerequisite for every organization’s existence, development, and success.
What is tax planning?
Tax planning is the review of one’s financial status from the perspective of tax efficiency in order to arrange one’s finances in the most efficient way possible.
It is the process of maximizing the use of different tax exemptions, deductions, and perks in order to reduce a taxpayer’s tax burden over the course of a fiscal year.
Making tax preparations is more than just lowering your tax bill. The goal is not to deprive the government of its rightful revenue.
Tax planning is related to effective tax management, with the proper understanding of tax laws and rules and their applicability in the right location to draw the right sort of advantages according to a strategic plan.
Tax evasion provides a short-term benefit, but it might expose the taxpayer to many obligations in the future. Planning your taxes, on the other hand, may help one save money in a legal method, resulting in more and more savings in addition to tax savings.
Tax planning is synonymous with financial planning, which is devising a strategy to meet your short- and long-term financial objectives. Without applying these tactics to fulfill those goals, it is difficult to successfully prepare for your present condition or future.
Taxes will be a significant expenditure if you are financially successful. Cutting less on taxes, or even eliminating them entirely if feasible, is a crucial part of maintaining your wealth.
The concept behind tax planning
Tax planning is adhering to the tax laws in such a way that all tax exemptions, deductions, concessions, refunds, and reliefs available under the Income Tax Act are fully utilized, resulting in the lowest possible tax incidence.
Tax planning is not the same as evasion or avoidance; rather, it is the methodical arrangement of an assessee’s operations in order to attract the lowest tax liability.
It could also be to postpone or, in some cases, defer liability for a later period by taking advantage of various incentives, concessions, allowances, rebates, and reliefs provided by the tax laws. They are intended to be used, and they have certain goals to achieve.
The government’s intention to reward and channel funds in specific ways is the motivation for such deductions, refunds, and other measures.
Money raised through infrastructure bonds, for example, is used to fund infrastructure development in the country, such as the construction of roads and water lines.
The government encourages tax planning since it not only saves money but also helps the government meet other objectives.
The basic goal of tax preparation is to ensure that you approach taxes as effectively as possible. Planning lowers your tax obligation by using efficient techniques that look for ways to cut taxes while also securing a more secure future and retirement.
It makes no difference if you earn $50,000 or $500,000 a year. You can find countless methods to save money if you take the time to establish a tax strategy.
Developing measures for tax planning
Tax planning should never be done with the intention of defrauding the government of funds. Even though all of an assessee’s transactions are legally valid when viewed individually, these transactions may be designed to cheat the revenue as a whole.
To put this to the test, planning for whatever tax should be right in both form and content. Any tax planning mechanism is put to the ultimate test when it comes to the form and substance of a transaction.
The form of transaction refers to a transaction as it looks on the surface, with the true objective of the transaction hidden. The term “substance of a transaction” refers to piercing the veil of legal documents and determining the genuine intentions of the parties involved.
Though the savings limit is quite low, implementing solid tax planning techniques is not only legal but also prudent.
Advantages of tax planning
a) Making claims
An assessee may claim a deduction under section 80-IB if he or she does business in an industrially backward state. This is a case of tax preparation in action.
Individuals can claim a deduction under Section 80C by contributing to a PPF, paying school tuition costs, paying life insurance premiums, and investing in infrastructure bonds, among other things.
b) Take Advantage of Tax-Advantaged Accounts
In the majority of situations, this entails making use of retirement savings programs. Depending on the sort of plan you select, you may be able to lower your current or future tax burden.
You may only contribute a certain amount to a standard IRA, 401(k), or Roth IRA, regardless of which you pick. Because the amounts fluctuate significantly across the four, it’s a good idea to consult a tax advisor to determine which option is best for you.
When it comes to deferring taxes, traditional 401(k)s and IRAs are the best options. When you want to invest in something that can grow tax-free, Roth 401(k)s and IRAs are the finest options.
c) Minimize litigation
Tax evasion and avoidance are mostly motivated by excessive taxes. Planning aids in the resolution of tax issues with federal, state, and municipal governments.
Tax planning bridges the gap between taxpayers and the government, as the government strives to collect as much revenue as possible while people aim to pay the least amount of tax feasible. As a result, tax preparation protects people and businesses from legal obligations.
d) Stability in the Economy
The money raised through taxes is used to fund the country’s development efforts. Effective tax planning ensures a steady flow of funds that helps the economy grow.
Individual and corporate tax preparation makes more money accessible for personal usage and reduces the danger of bankruptcy caused by bill and loan repayment challenges. Both people and the country benefit from a healthy economy.
See Also: 9 States With No Income Tax in 2022
Why do you need tax planning?
Effective planning is critical to achieving high real returns in the present global atmosphere of ultra-low bank interest rates and economic uncertainty. Outpacing the cost of living and optimizing earnings requires careful tax planning.
Inflation, costs, and taxes are all taken into consideration when determining the investment value. For example, the property is lauded for delivering strong long-term returns.
However, when capital gains, stamp duty, and wealth taxes are added, the tax burden might be quite high.
Individuals should ensure that their investment portfolio is well-diversified and tailored to their own requirements and objectives. Taxes are likely to drastically limit returns if appropriate tax preparation is not implemented.
Types of tax planning
1) Permissive tax planning
This method of tax planning complies with the rules governing taxation. Different nations provide measures such as exemptions, deductions, and incentives for tax planning.
Under India, for example, the Income Tax Act of 1961 specifies the sorts of deductions available in various tax instruments. Permissive planning is carried out in accordance with tax legislation.
2) Short-range tax planning
At the conclusion of the fiscal year, tax planning is undertaken and implemented. Individuals and businesses wishing to invest use short-term tax planning to reduce their tax bills at the conclusion of each fiscal year. Despite the fact that this strategy does not need long-term commitments, it does result in significant savings.
3) Long-range tax planning
This strategy involves preparing at the start of the year and taxpayers adhering to the plan until the conclusion of the year.
This form of preparation does not provide immediate tax savings, but it will save you money in the long term.
4) Purposive tax planning
Purposive tax planning is using taxation as a tool to provide tax benefits depending on national goals.
It employs tax-saving techniques with the express goal of maximizing returns through proper investment selection, asset replacement, and diversification of income and company activities.
The income of other individuals included in the accesses income is discussed in sections 60 to 65 of the Income Tax Act. This sort of tax planning makes use of legal loopholes.
Should I hire a consultant?
It is virtually always a good idea to hire a tax planning specialist. Finding a consultant should be one of your top priorities if you’re having problems comprehending your taxes or why tax planning is vital.
You may save money by carefully evaluating your taxes ahead of time. The best approach to get the most out of your tax strategy is to use a tax planner.
Using tax planning services and working with a tax consultant protects your investments and gains.
The correct counsel will recognize the value of tax planning and will assist you in comprehending it. By better understanding investment decisions, you may achieve tax efficiency through tax planning.
Tax planning vs tax management
The correct allocation of earned money is defined by tax planning. It considers tax deducted/collected at source (TDS/TCS), advance tax payments due, and different deductions and exclusions available under the Income Tax system.
It may require us to save on tax-avoidance tools at times, but this should not be the primary goal of the process. The goal is to decrease the tax burden within the legal framework by ensuring that proper tax methods are used.
Tax management is then the management of one’s finances in order to meet up with tax demands.
Hence, planning comes before the money is earned and management comes after the money has been earned.
Tax preparation is more than just lowering your tax bill. The goal is not to deprive the government of its rightful revenue.
Adequate planning is related to effective tax management, with the proper understanding of tax laws and rules, measures can be applied in the right location to draw the right sort of advantages according to a strategic plan.