Tax Planning

What is Tax Planning?

Tax Planning is minimizing your tax liability by making the best use of all available deductions, allowances, rebates, thresholds, etc as permitted by income tax laws, rules stipulated by the government of a country. It helps in effective cash flow and liquidity management for taxpayers and better retirement plans and investment opportunities.

Types of Tax Planning

Now let’s discuss the 3 different types in detail.

Tax-Planning

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Examples of Tax Planning

Let’s take some examples to understand this concept.

Example #1

For married couples or civil partners where one partner is a basic rate taxpayer, and the other is a higher rate taxpayer, it is logical that the person who has the lowest income to receive the taxable rental income. This is generally cost-efficient, where there is a loan on the property as interest relief will be restricted in future periods.

Example #2

John is starting a new business and expects to make annual profits of £37,500 before tax and national insurance.

Consider the financial effect of his choosing to trade as a sole trader or, alternatively, through a company, paying him a salary of £12,500 and then the largest possible dividendDividendDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company.read more, not giving rise to a loss of capital. Assume that 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 equal taxable trade profits and that alan will be the sole employee and a director of the company. Use 2017/18 tax rates.

Importance

They can have some great benefits for any business regardless of nature and size; few of them are listed below:

Disadvantages

The only minor disadvantage is that it could lead to blockage of your money into buying of tax saver products such as ULIPS, Mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks.read more, Life insurance, bonds, etc. which could impact your short-term liquidity and buying these products just for the sake of tax savings and ignoring other aspects such as annual returns.

Limitations

Some of the limitations are as follows:

Changes in Tax Planning

  • The consequences of tax changes should be anticipated and considered as you evaluate choices for financial strategies. You can usually be aware of any tax law changes well in advance to incorporate them into your planning.
  • Tax deductions, allowances, and slab rates tend to frequently change every year as per the economic scenario and taking into government fiscal targets. These changes must be kept in mind while doing tax planning as a ready reckoner.
  • Changes in tax laws are brought in sometimes to boost the economic scenario, infrastructure growth, and industrial development. For example, recently, the scope of capital gains tax in the UK for Non-UK residents was extended to include all disposals of UK property. These are just the first in the line of reforms coming down the track in the next few years that will have a significant impact on landlords.

Conclusion

Tax planning has numerous advantages and lesser disadvantages. They should be done within the applicable limits of tax laws and clearly distinguished with tax evasion or tax avoidance, both of which are not allowable under the applicable limits of tax laws. Also, any changes in tax laws should be kept into consideration.

They can only be done up to a certain amount limit as per the thresholds fixed by the government tax laws. There are many tax-saving financial products available in the financial markets. Those products need to be evaluated with pros and cons before buying the same and whether it can actually lead to tax savings or not.

Recommended Articles

This article has been a guide to what is tax planning and its meaning. Here we discuss types and examples of tax planning along with importance & limitations. You can learn more about accounting from the following articles –

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