Basics of Tax Planning

As an individual taxpayer and business owner you will often have options as to when and how to complete a taxable transaction. You have the right to choose the timing and method that results in the lowest tax liability. There is nothing wrong or illegal about tax planning or tax avoidance, as long you don’t use illegal means. Illegal means includes deceit, subterfuge or concealment. Steering clear of these leaves quite a bit of room to maneuver.

Every tax planning strategy is based upon structuring a transaction to accomplish one or more of the following often-overlapping goals:

A. Lower Taxable Income

By lowering taxable income, one lowers the amount of taxes due. Many strategies to reduce taxable income will simply delay or defer the recognition of income. This alone is valuable, of course, given the time value of money. Other tactics include increasing tax-deductible expenses, moving income to entities that enjoy lower tax rates, or generating losses to offset investment gains. For more detail, see article herein titled Tax Planning for Individuals and Families.

B. Claim All Available Tax Credits

Tax credits are dollar for dollar reductions to your tax bill. Deductions are dollar for dollar reductions of your taxable income. There is a big difference. Tax credits are much more valuable than deductions because a $100 credit reduces your tax bill by $100, regardless of your tax bracket. In contrast, a deduction simply reduces your taxable income by the product of the deduction amount times the applicable tax rate. For example, if you are in the 33 percent tax bracket, a $100 deduction will reduce your taxes by $33. For a review of tax credits available, see article herein titled Tax Planning for Individuals and Families.

C. Lower The Applicable Tax Rate

Such strategies include the rationalization of taxable income between tax years in light of marginal tax rates; moving income to persons or entities that are taxed at lower rates; moving income into accounts that are non-taxable or tax deferred; or conducting transactions in a manner that qualify for lower rates (such as long-term vs. short term capital gain rates).

D. Control The Effects Of The Alternative Minimum Tax (AMT)

The AMT was established in 1986 to ensure that higher income individuals and corporations pay at least a basic level of tax, regardless of the number of tax credits and deductions that they garner. It requires that federal income taxes be calculated by two separate and distinct methods – regular tax laws and AMT laws. You pay the higher of the two. C-corporations with annual revenues under $5 million (and in some cases up to $7.5 million) are exempt. Individual taxpayers that have incomes over $75,000 face heightened risk of triggering AMT taxes. AMT tax rates are lower, such as 26 percent and 28 percent for individuals, but far fewer credits and deductions are allowed. For more information, see article in this issue titled Tax Planning for Individuals and Families.