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Tax Planning Strategies for Beginners

Updated: Apr 14

Tax Planning Strategies

The tax planning strategy is the roster of the tax paying chart where a taxpayer can ensure to pay the lowest taxes possible. It comes after having a brief analysis of the financial situation and considering all major factors that might affect the tax planning.

Taxes are a necessity you can't avoid; rather, making a suitable plan helps minimize the tax. First-time taxpayers might feel the requirement to understand the unfamiliar areas of liability, deduction, and protecting financial assets or saving for the future.

Learning tax paying strategies offer many benefits to taxpayers, beyond tax savings. The process helps taxpayers to manage their finances effectively by reducing the total capital outflow and adding more sum into their pockets.

What is tax planning?

Tax planning generally refers to a systematic way to reduce tax liability regarding exemptions, deductions, or tax benefits. According to the process, taxpayers must analyze their financial situation logically to build the right framework for paying taxes.

Benefits of tax planning

To minimize litigation: Tax planning helps resolve disputes with local, federal, or foreign tax authorities. When done mindfully, it minimizes the chances of getting sued or legal action against the taxpayer.

To reduce tax liabilities: Taxpayers wish to reduce their tax burden as soon as possible. A taxpayer can lower their tax amount by utilizing benefits offered under the Income Tax Act, 1961. The Act comes with many schemes with tax benefits.

To ensure economic stability: Effective tax planning supports the economy's healthy white flow by tracing black money dealers. Taxpayers' money is devoted to the betterment of the country. It results in the sound progress of the nation.

To leverage productivity: Tax planning improves productivity by channeling funds and taxable sources utilizing funds in required areas for growth.

Types of Tax Planning

1. Short-Term Tax Planning

At the end of the fiscal year, short-term tax planning is put into action. Before the financial year ends, taxpayers use this preparation to legally reduce their tax liability.

2. Long-Term Tax Planning

Taxpayers employ a long-term tax preparation strategy that begins at the beginning of the fiscal year. If employed methodically and in flow, this planning is beneficial for long-term tax benefits.

3. Permissive Tax Planning

Under the Income Tax Act of 1961, permissive tax planning provides taxpayers with a number of advantages, including deductions, exemptions, contributions, and incentives. Before implementing this planning, certain legal laws and provisions need to be examined.

4. Purposive Tax planning

Taxpayers must adopt the correct mindset while creating a framework for how to ensure that they will benefit from their investments if they are to engage in purposeful tax planning. This planning necessitates a suitable agenda for replacing assets, company diversification, and other suitable taxpayer investments

How Tax Planning Strategies Benefit Businesses

1. Accelerate or Defer Income

For maintaining tax records and bookkeeping tax filings, many businesses employ the cash method of accounting. The cash method helps companies recognize income and its flow or where money is being exchanged. Tax planning strategy helps taxpayers to defer some tax amount by expecting the lower tax bracket.

2. Understand your tax bracket

Keeping your business up to date helps form the right tax-paying strategy to avoid the future rush. The United States has a progressive tax system. People on higher taxable incomes are subject to higher tax rates, while lower tax rates are subjected to lower taxable income.

There are in general seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%.

Difference between tax deductions and tax credits

Tax deductions and tax credits can combine or reduce the tax bill separately but in different ways. Tax credits help reduce the amount of tax you owe to the Internal Revenue Service. It can also allow you to claim tax deductions as well. A tax deduction allows taxpayers to reduce their taxable income and pick one from a standard or itemized deduction.

Analyzing Standard deduction v/s itemizing

Selecting the one mode of paying tax with either standard or itemized deduction is one of the crucial phases of tax planning strategies. This choice can make a huge difference in your tax-paying bill amount.

Standard deduction counts under the flat deduction of the amount from taxpayers earning a salary.

The portion of income that does not fall for paying tax can be used to reduce the tax bill. The standard deduction is usually paid off from the gross salary and can be claimed as an exemption without showing any proof of expenses.

The itemizing deduction includes the amount that is supposed to be paid for the state, local sales taxes, and many other real estates, personal property, and other disaster losses.

People usually prefer itemize their deductions to add up more than standard and pay fewer taxes.

Examples of Beneficial Tax Planning Strategies

Business tax planning strategies are helping taxpayers in several forms to reduce their bill pay to manage federal and state taxes. Here are some common examples of beneficial tax planning strategies are:

  • Utilize Depreciation:

Depreciation helps businesses to get a quick recovery from expenditure and capital expenses. This expense will reduce the income tax amount and ease the tax burden. Taxpayers can make business savings when depreciation methods accelerate deductions with higher tax rates for years. Businesses should take a comprehensive and proactive approach while checking and updating material deductions and all associated credits with important tax planning pieces.

  • Cost Segregation:

Cost segregation is the most approached and utilized way to speed up the cash flow by using deprecation effectively. This method examines the buildings and identifies separate assets that can depreciate over the recovery phase. Real estate owners majorly accepted and implied it as a strategic tax planning tool that allows companies who have constructed, purchased, and expanded cash flow by hiking depreciation deductions and deferring federal and state taxes.

  • Timing Consideration:

Earlier recognition of business income and expenditure is beneficial for managing and considering all tax liabilities. At the earliest, businesses start forming the right tax paying strategies for their financial stake helps them save liquidated money.

  • Section 199A

Qualified business income is eligible for a 20% deduction under Section 199A of the Tax Cuts and Jobs Act. Pass-through income is like sole proprietorships, partnerships, and S corporations can hike qualified business income.

  • Accounting Method Planning

Tax planning strategies focus on generating tax benefits by accelerating tax benefits and deferring the tax payable amount by reducing the current year owed tax of payers. The accrual and Cash methods are the two most commonly used methods in accounting tax planning strategies.

Accrual uses the most advanced financial accounts and helps track long-term liabilities, loans, and inventory. At the same time, cash methods help taxpayers to track their cash flow, expenses, and income.

  • Utilization of Charitable Contribution

Contribution accepted by qualified charities funds helps businesses securely frame the maximum tax benefits. It can include many contributors such as cash, stock, IRA, Private Foundations, and Charitable remainder trusts.

  • Pass-Through Entity Taxes (PTET)

The pass-through entity tax is an entity-level tax that partnerships or S corporations annually elect to pay on certain income for tax years. Under the Tax Cuts and Jobs Act, the deduction limit for state and local taxes is not more than $10,000 for tax years from 2018- 2025. This tax planning will eliminate the process of double taxation.

Resources for Individual Tax Planning Strategies

Utilize the best tax planning agency to maximize your tax benefits.

We are here to assist you in developing a successful tax planning strategy.

Consult with experts immediately to find the best answer to the complexity of taxes.

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