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Tax Planning

Updated on April 26, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Tax Planning Meaning

Tax planning or analysis is a lawful method to reduce tax liabilities over a calendar year by capitalizing on tax deductions, benefits, and exemptions. It assists the taxpayers in obtaining commercial security and retirement savings with the decreased fiscal burden. Nevertheless, tax planning for individuals does not include tax avoidance or tax evasion.

Tax Planning Meaning

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This certainly aids in the proper usage of full benefit via all favorable tax law provisions. Moreover, it has three types, i.e., purposive, permissive, and short and long-range tax analysis.

Key Takeaways

  • Tax planning is a legal approach to lowering the tax burden through tax benefits, deductions, and exemptions. It has three types, i.e., permissive, purposive, and short and long-range.
  • It assists the taxpayers in obtaining tax efficiency by adequately planning their expenses and accumulating retirement savings.
  • The tax analysis strategies incorporate broadening the outlook, making annual affordable commitments, and evaluating post-tax returns.
  • The objectives of tax analysis are decreased litigation, financial stability, economic expansion, lesser total tax burden, and profitable investment.

Tax Planning Explained

TTax planning implies evaluating the taxpayer’s financial condition and conceiving approaches to surge tax efficiency ethically, both in corporate and non-commercial industries. This certainly helps them plan their capital budgetCapital BudgetCapital budgeting is the planning process for the long-term investment that determines whether the projects are fruitful for the business and will provide the required returns in the future years or not. It is essential because capital expenditure requires a considerable amount of funds.read more and expenditures better.

It is completely legitimate if tax planning for retirement is executed according to the regulatory framework and also helps save one’s inheritance. Nonetheless, utilizing questionable strategies like tax evasionTax EvasionTax Evasion is an illegal act in which the taxpayers deliberately misreport their financial affairs to reduce or evade the actual tax liability. This includes using multiple financial ledgers, hiding or representing lesser income, gains, or profits than actually earned, overstating deductions, & failing to file returns. read more is strongly discouraged and is liable to litigation. It has two major categories, namely, Corporate and Inheritance tax analysis.

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Here, corporate tax planning refers to the cutback of the tax burden on a registered firm through employee health insurance, business transport, retirement planning, office expenses, etc. Contrastingly, Inheritance tax planning implicates the procedure of passing on the earnings of an estate to the selected beneficiary.

Corporate tax planning aids in decreasing direct and indirect tax liabilities during inflation. Conversely, inheritance tax planning lets the individuals draft a tax-efficient will so that the heirs can live a stress-free life.

Simply put, adequate corporate or uncommercial tax planning for individuals is an outcome of:

Types Of Tax Planning

To clarify, there are three types of tax planning for individuals:

  1. Purposive: It indicates the planning of taxes with a specific aim.
  2. Permissive: This type of tax analysis is performed as per the regulations of the nation’s taxation laws.
  3. Long-Range And Short-Range: Here, long and short-range tax planning for retirement is conceptualized at the beginning and end of a financial year, respectively.
Tax Planning Types

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Tax Planning Strategies

Now, let’s explore a few smart tax analysis strategies:

#1 – Make Inexpensive Yearly Commitments

As lucrative as it may sound, every insurance scheme is not worth the investment. Hence, taxpayersTaxpayersA taxpayer is a person or a corporation who has to pay tax to the government based on their income, and in the technical sense, they are liable for, or subject to or obligated to pay tax to the government based on the country’s tax laws.read more must only put their finances into a product or service that is both cheap and profitable in the long run. They must check their available funds to examine their affordability to retain the investment.

#2 – Analyze Post Tax Returns

While evaluating the tax returns, taxpayers must not let the profitable-yet-suspicious policies distract them. Please note that comprehending tax implications is of paramount importance. Rather, they must check out products with tax-free profits like Public Provident Fund (PPF) and Mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more.

#3 – Broaden The Outlook

Taxpayers must channel their annual returnsAnnual ReturnsThe annual return is the income generated on an investment during a year as a percentage of the capital invested and is calculated using the geometric average. This return provides details about the compounded return earned yearly and compares the returns supplied by various investments like stocks, bonds, derivatives, mutual funds, etc.read more into policies with long-term benefits. For instance, investing in long-term debt instrumentsDebt InstrumentsDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans.read more assists them in leveraging the offered withdrawal alternatives. Then, they may reinvest the collected maximum tax-free capital amount in a financial vehicle like Equity Linked Savings Scheme (ELSS).

Examples

For better understanding, here are some examples.

Example #1

Davina is the owner of a multinational toy manufacturing firm. First, she assesses the taxable aspects of her annual income ($20000) and computes the payable tax amount. Then, she invests in financial instruments with maximum tax benefitsTax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more.

She invests in PPFs, mutual funds, ELSS, and many other debt fundsDebt FundsDebt fund are investments, such as a mutual fund, closed-end fund, ETF, or unit investment trust (UTI), that primarily invest in fixed-income instruments like bonds or other types of a debt security for returns.read more. Consequently, these investments lower her taxable pay amount by 40% ($8000). So, her tax liability over a fiscal yearFiscal YearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th Septemberread more is now worth $12000.

Example #2

Proactive tax analysis certainly assists small enterprise owners in decreasing their tax liabilities. So here lies a few tax deductions to save the maximum amount of money.

  1. Health insurance premiums
  2. Retirement plan contributions
  3. Professional and legal services
  4. Business marketing
  5. Insurance premiumsInsurance PremiumsInsurance Premium is the amount paid by any individual or a corporate entity to cover themself from uncertain events resulting in heavy economic and non-economic losses.read more related to the business
  6. Business-related automobile expenditures
  7. Home office discounts
  8. Taxes and licensing for the business
  9. Office supplies
  10. Self-employment taxSelf-employment TaxSelf-employment tax is the tax towards social security and Medicare, paid by a self-employed person who has net earnings of $400 or more for the concerned tax period towards the federal government reported through form 1040 schedule SE.read more
  11. Cell phone

Tax Planning Objectives

Generally, the primary goals of tax analysis are:

Tax Planning Objectives

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#1 – Financial Soundness

Please note that the superior tax analysis of an entity is the ultimate testament to its monetary stability and accounting profitsAccounting ProfitsAccounting profit is the net income available after deducting all explicit costs and expenses from total revenue, and it is calculated in accordance with generally accepted accounting principles (GAAP). Operating expenses, labour, transportation, and sales expenses are common examples of these costs.read more.

#2 – Decreased Litigation

Appropriate tax analysis certainly assists avoid the usual disagreement between the taxpayersTaxpayersA taxpayer is a person or a corporation who has to pay tax to the government based on their income, and in the technical sense, they are liable for, or subject to or obligated to pay tax to the government based on the country’s tax laws.read more and tax collectors.

#3 – Minimal Gross Tax Burden

Tax analysis undoubtedly lets the taxpayers exploit the available tax benefits, exemptions, and deductions. In addition, it helps arrange the taxpayers’ commercial operations as per their tax decisions. As a result, it saves the maximum capital amount from being included in the tax liabilities.

#4 – Economic Expansion

The growth of a nation is directly related to the development of its citizens. As tax analysis facilitates the flow of white money, it certainly boosts the country’s fiscal standing.

#5 – Profitable Investment

The more the taxpayers save on their tax liabilities, the more they can devote it to a profitable channel. That is to say, an entity with quality tax analysis can direct its earningsEarningsEarnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more into productive investments or dividendsDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. Consequently, this assists in smart investments with optimum utilization of the available resources.

Frequently Asked Questions (FAQs)

What Is Meant by Tax Planning?

Tax planning is a legal procedure of diminishing tax liabilities by optimally utilizing the tax rebates, deductions, and benefits. It assists the taxpayers in properly planning their annual budget and gaining maximum retirement savings. It has three types, namely, short and long-range, permissive, and purposive tax planning.

Is Tax Planning Legal or Illegal?

Tax planning is a legal approach to acquiring tax savings. The process is legalized as long as the taxpayers don’t intentionally choose tax avoidance or evasion. Moreover, this may include investment in long-term debt vehicles like municipal bonds, ELSS, mutual funds, PPF, etc.

Why Tax Planning Is Important?

Tax planning is important because it confirms savings on taxes that, in turn, financially strengthen the taxpayers and also helps them easily pass on their inheritance to the beneficiaries. Also, it offers numerous advantages such as decreased litigation, lesser tax burden, assured national economic growth, and increased productivity. This lets them build their finances and level up their fiscal stature.

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