With the tax preparation season winding down, either you complied and filed by March 15 or April 15, 2019 or extended your tax returns until September or October 2019, regardless of your choice, the common discussion during this period has been: “How did the new tax laws affect you?” The only way to find out is through Tax planning. Some people had or will have favorable results, and some lost or will lose a lot, but without planning ahead there is no way to find out which side you will be on.
For many taxpayers tax planning will be something new as they are used to talking to their Tax Professional between January and April only to drop off their tax documents and file their tax returns to receive a refund or pay the tax due. That’s recording history and not much can be done after that year is over.
What is Tax Planning? It is an art of arranging your financial affairs and defers taxes through taking advantage of beneficial tax-law provisions, increasing and accelerating tax deductions, and tax credits. It is maximizing the use of all applicable tax breaks available under the Internal Revenue Code. Therefore, tax planning helps you determine what you should do today, when you should do it and how you should do it. This may result in substantial tax savings.
Tax is a kind of cost and reduction of cost increases profitability. The best strategy is to time your income so that it will be taxed at a lower rate and to time your deductible expenses so that they are claimed in years when you are in a higher tax bracket.
Your most direct control over your tax bracket rests in your ability to control the timing of your income and deductible expenses. However, you should also be aware of more indirect factors that can change your tax bracket from one year to the next. Such as:
- Filing Status. For married couples, the filing choices are “married filing jointly” and “married filing separately”. A single person generally selects “single” filing status. However, a single person who lives with and provides support for a dependent may file as “head-of-household”.
- Income level. The biggest variable determining your marginal tax rate is your income level. Big changes in income from last year to this year may warrant several tax planning opportunities. Marriage and divorce often have a drastic effect on your income level. Other factors are: Whether you are a W2 employee; a business owner (what type of entity you are operating your business? are you an independent contractor, S corporation, C corporation, Limited Liability Company, Partnership, etc.) and the types of investments you are investing in, are they short-term or long term?
There are several ways of Tax Planning:
- Short-term Planning: This is planning executed at the end of the income year to reduce taxable income in a legal way. Suppose, at the end of the year, you discover that your taxes have been too high in comparison with last year, you can make proper arrangements to get them reduced before the end of the year through tax planning. It does not involve a long-term commitment, but results in substantial tax savings.
- Long-term Planning: A planning done at the beginning of the income year to be followed for several years. This planning will not pay off immediately but is likely to help in the long run.
- Permissive tax Planning: This planning takes advantage of different incentives and tax deductions.
- Purposive Tax Planning: This is planning with a specific purpose to ensure availability of maximum benefits through a correct selection of investments, or replacement of assets, varying residential status and diversifying business activities and income.
There is a plan for everyone in making use of all the beneficial provisions in the tax law. Failing to Plan is planning to fail. When you plan, you are better prepared.
Esther Phahla is a Certified Public Accountant and Certified Tax Strategist in Temecula. She is the Best- Selling Author of 2 tax planning books: “Why Didn’t My CPA Tell Me That” and “10 Most Expensive Tax Mistakes That Cost Business Owners Thousands”. She also holds a Masters of Science in Taxation. She can be reached at (951) 514-2652 or visit www.estherphahlacpa.com