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Tax Planning: 7 Tax Strategies and Concepts to Know

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Tax planning is the analysis and arrangement of a person's financial situation to maximize tax breaks and minimize tax liabilities in a legal and an efficient manner.

Tax rules can be complicated, but taking some time to know and use them for your benefit can change how much you end up paying (or getting back) when you file on tax day .

Here are some key tax planning and tax strategy concepts to understand before you make your next money move.

Understand your tax bracket

Learn how tax credits and deductions work

Decide between the standard deduction and itemizing

Take advantage of popular tax credits and deductions

Keep good records

Tweak your W-4 if you need to

Leverage tax-advantaged accounts

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1. Tax planning starts with understanding your tax bracket

You can’t really plan for the future if you don’t know where you are today. So the first tax planning tip is to figure out what federal tax bracket you’re in.

The United States has a progressive tax system. That means people with higher taxable incomes are subject to higher tax rates, while people with lower taxable incomes are subject to lower tax rates. There are seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%.

No matter which bracket you’re in, you probably won’t pay that rate on your entire income. There are two reasons:

You get to subtract tax deductions to determine your taxable income (that’s why your taxable income usually isn’t the same as your salary or total income).

You don’t just multiply your tax bracket by your taxable income. Instead, the government divides your taxable income into chunks and then taxes each chunk at the corresponding rate.

Example: Let’s say you’re a single filer with $32,000 in taxable income. That puts you in the 12% tax bracket for the 2023 tax year (taxes filed in 2024). But do you pay 12% on all $32,000? No. Actually, you pay only 10% on the first $11,000; you pay 12% on the rest.

» MORE: See what tax bracket you’re in

2. The difference between tax deductions and tax credits

Tax deductions and tax credits may be the best part of preparing your tax return. Both reduce your tax bill but in very different ways. Knowing the difference can create some very effective tax strategies that reduce your tax bill.

Tax deductions are specific expenses you’ve incurred that you can subtract from your taxable income. They reduce how much of your income is subject to taxes.

Tax credits are even better — they give you a dollar-for-dollar reduction in your tax bill. For instance, a tax credit valued at $1,000 lowers your tax bill by $1,000.

3. Taking the standard deduction vs. itemizing

Deciding whether to itemize or take the standard deduction is a big part of tax planning because the choice can make a huge difference in your tax bill.

What is the standard deduction?

Basically, it’s a flat-dollar, no-questions-asked tax deduction. Taking the standard deduction makes tax prep go a lot faster, which is probably a big reason why many taxpayers do it instead of itemizing.

Congress sets the amount of the standard deduction, and it’s typically adjusted every year for inflation. The standard deduction that you qualify for depends on your filing status , as the table below shows.

What does 'itemize' mean?

Instead of taking the standard deduction, you can itemize your tax return, which means taking all the individual tax deductions that you qualify for, one by one.

Generally, people itemize if their itemized deductions add up to more than the standard deduction. A key part of their tax planning is to track their deductions through the year.

The drawback to itemizing is that it takes longer to do your taxes, and you have to be able to prove you qualified for your deductions.

You use IRS Schedule A to claim your itemized deductions.

Some tax strategies may make itemizing especially attractive. For example, if you own a home, your itemized deductions for mortgage interest and property taxes may easily add up to more than the standard deduction. That could save you money.

You might be able to itemize on your state tax return even if you take the standard deduction on your federal return.

The good news: Tax software or a good tax preparer can help you figure out which deductions you’re eligible for and whether they add up to more than the standard deduction.

» MORE: Find the right tax software for your tax situation this year

4. Keep an eye on popular tax deductions and credits

Hundreds of possible deductions and credits are available, and there are rules about who’s allowed to take them. Here are some big ones (click on the links to learn more).

» MORE: See a list of 20 common tax breaks

5. Know what tax records to keep

Keeping tax returns and the documents you used to complete them is critical if you’re ever audited . Typically, the IRS has three years to decide whether to audit your return, so keep your records for at least that long. You also should hang on to tax records for three years if you file a claim for a credit or refund after you've filed your original return.

Keep records longer in certain cases — if any of these circumstances apply, the IRS has a longer limit on auditing you:

Six years: If you underreported your income by more than 25%.

Seven years: If you wrote off the loss from a “worthless security.”

Indefinitely: If you committed tax fraud or you didn’t file a tax return.

» MORE: See more about how long to keep your tax records

6. Tweak your W-4

A W-4 tells your employer how much tax to withhold from your paycheck. Your employer remits that tax to the IRS on your behalf.

Here's how to use the W-4 for tax planning.

If you got a huge tax bill when you filed and don’t want to relive that pain, you may want to increase your withholding. That could help you owe less (or nothing) next time you file.

If you got a huge refund last year and would rather have that money in your paycheck throughout the year, do the opposite and reduce your withholding.

You probably filled out a W-4 when you started your job, but you can change your W-4 at any time. Just download it from the IRS website, fill it out and give it to your human resources or payroll team at work. You may also be able to adjust your W-4 directly through your employment portal if you have one.

» MORE: Learn how FICA and other payroll taxes work

7. Tax strategies to shelter income or cut your tax bill

Deductions and credits are a great way to cut your tax bill, but there are other tax planning strategies that can help with tax planning. Here are some popular strategies.

Put money in a 401(k)

Your employer might offer a 401(k) savings and investing plan that gives you a tax break on money you set aside for retirement.

The IRS doesn’t tax what you divert directly from your paycheck into a 401(k). In 2024, you can funnel up to $23,000 per year into an account. If you’re 50 or older, you can contribute up to $30,500.

While these retirement accounts are usually sponsored by employers, self-employed people can open their own 401(k)s .

If your employer matches some or all of your contribution, you’ll get free money to boot.

» MORE: Calculate how much you should put in your 401(k)

Put money in an IRA

Outside of an employer-sponsored plan, there are two major types of individual retirement accounts : Roth IRAs and traditional IRAs.

You have until the tax deadline to fund your IRA for the previous tax year, which gives you extra time to do some tax planning and take advantage of this strategy.

The tax advantage of a traditional IRA is that your contributions may be tax-deductible. How much you can deduct depends on whether you or your spouse is covered by a retirement plan at work and how much you make. You pay taxes when you take distributions in retirement (or if you make withdrawals prior to retirement).

The tax advantage of a Roth IRA is that your withdrawals in retirement are not taxed. You pay the taxes upfront; your contributions are not tax-deductible.

Earnings on your investments grow tax-free in a Roth and tax-deferred in a traditional IRA.

This table illustrates these accounts in action.

» MORE: How to find the right kind of IRA for you

Open a 529 account

These savings accounts, operated by most states and some educational institutions, help people save for college.

You can’t deduct contributions on your federal income taxes, but you might be able to on your state return if you’re putting money into your state’s 529 plan.

There may be gift-tax consequences if your contributions plus any other gifts to a particular beneficiary exceed $17,000 in 2023 or $18,000 in 2024.

» MORE: Learn more about how 529s work

Fund your flexible spending account (FSA)

If your employer offers a flexible spending account , take advantage of it to lower your tax bill. The IRS lets you funnel tax-free dollars directly from your paycheck into your FSA every year. In 2024, the limit is $3,200.

You’ll have to use the money during the calendar year for medical and dental expenses, but you can also use it for related everyday items such as bandages, sunscreen and glasses for yourself and your qualified dependents. You may lose what you don’t use, so take time to calculate your expected medical and dental expenses for the coming year.

Some employers might let you carry over up to $640 to the next year.

Use dependent care flexible spending accounts (DCFSAs)

This FSA with a twist is another handy way to reduce your tax bill — if your employer offers it.

The IRS will exclude up to $5,000 of your pay that you have your employer divert to a dependent care FSA account, which means you’ll avoid paying taxes on that money. That can be huge for parents, because before- and after-school care, day care, preschool and day camps are usually allowed uses. Elder care may be included, too.

What’s covered can vary among employers, so check out your plan’s documents.

Maximize health savings accounts (HSAs)

Health savings accounts are tax-exempt accounts you can use to pay medical expenses.

Contributions to HSAs are tax-deductible, and the withdrawals are tax-free, too, so long as you use them for qualified medical expenses.

If you have self-only high-deductible health coverage, you can contribute up to $4,150 in 2024. If you have family high-deductible coverage, you can contribute up to $8,300 in 2024. If you're 55 or older, you can put an extra $1,000 in your HSA.

Your employer may offer an HSA, but you can also start your own account at a bank or other financial institution.

» MORE: See the tax benefits of FSAs and HSAs

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What Is Tax Planning?

Understanding tax planning, retirement saving strategies.

• Tax Gain-Loss Harvesting

The Bottom Line

• Investing Basics

Tax Planning: What It Is, How It Works, Examples

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Investopedia / Joules Garcia

Tax planning is the analysis of a financial situation or plan to ensure that all elements work together to allow you to pay the lowest taxes possible. A plan that minimizes how much you pay in taxes is referred to as tax efficient . Tax planning should be an essential part of an individual investor's financial plan. Reduction of tax liability and maximizing the ability to contribute to retirement plans are crucial for success.

Key Takeaways

• Tax planning is the analysis of a financial situation or plan to ensure that all elements work together to allow you to pay the lowest taxes possible.
• Considerations of tax planning include the timing of income, size, the timing of purchases, and planning for expenditures.
• Tax planning strategies can include saving for retirement in an IRA or engaging in tax gain-loss harvesting.

Tax planning covers several considerations. Considerations include timing of income, size, and timing of purchases, and planning for other expenditures. Also, the selection of investments and types of retirement plans must complement the tax filing status and deductions to create the best possible outcome.

Saving via a retirement plan is a popular way to efficiently reduce taxes. Contributing money to a traditional IRA can minimize gross income by the amount contributed. For 2023, if meeting all qualifications, a filer under age 50 can contribute a maximum of $6,500 to their IRA with an additional catch-up contribution of $1,000 if age 50 or older. That number rises to $7,000 in 2024, with the catch-up contribution holding steady at $1,000.

If an individual who made $75,000 a year contributed a total of $7,000 to a traditional IRA in 2024, they would have an adjusted gross income of $68,000 ($75,000-$7,000) on which they would be taxed. The $7,000 would then grow tax-deferred until withdrawn.

There are several other retirement plans that an individual may use to help reduce tax liability. 401(k) plans are popular with larger companies that have many employees. Participants in the plan can defer income from their paycheck directly into the company’s 401(k) plan. The greatest difference is that the contribution limit dollar amount is much higher than that of an IRA . 

In 2023, the contribution limit for a 401(k) is $22,500, increasing to $23,000 in 2024. For both years, if you are 50 and over, you can contribute an additional $7,500.

If we take the example above, if an individual contributed $23,000 in 2024, their adjusted gross income would be $52,000 ($75,000-$23,000) on which they would be taxed. The $23,000 would grow tax-deferred until withdrawn.

Tax Planning vs. Tax Gain-Loss Harvesting

Tax gain-loss harvesting is another form of tax planning or management relating to investments. It is helpful because it can use a portfolio's losses to offset overall capital gains. According to the IRS, short and long-term capital losses must first be used to offset capital gains of the same type.

In other words, long-term losses offset long-term gains before offsetting short-term gains. Short-term capital gains, or earnings from assets owned for less than one year, are taxed at ordinary income rates. 

In 2023, long-term capital gain limits are the following:

• 0% for single filers whose income is no more than $44,625 ($89,250 in the case of a joint return or widow(er), $59,750 in the case of an individual who is head of household, $44,625 in the case of a married individual filing a separate return)
• 15% tax for single filers whose income is between $44,626 and $492,300 ($553,850 in the case of a joint return or widow(er), $523,050 in the case of an individual who is the head of a household, or $276,900 in the case of a married individual filing a separate return)
• 20% tax for those whose income is higher than that listed for the 15% tax

In 2024, long-term capital gain limits will be increasing to the following:

• 0% for single filers whose income is no more than $47,025 ($94,050 in the case of a joint return or widow(er), $63,000 in the case of an individual who is head of household, $47,025 in the case of a married individual filing a separate return)
• 15% tax for single filers whose income is between $47,026 and $518,900 ($583,750 in the case of a joint return or widow(er), $551,350 in the case of an individual who is the head of a household, or $291,850 in the case of a married individual filing a separate return)

For example, if a single investor whose income was $100,000 had $10,000 in long-term capital gains, there would be a tax liability of $1,500. If the same investor sold underperforming investments carrying $10,000 in long-term capital losses, the losses would offset the gains, resulting in a tax liability of 0. If the same losing investment were brought back, then a minimum of 30 days would have to pass to avoid incurring a wash sale .  

According to the Internal Revenue Service, "If your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your income is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 16 of  Schedule D (Form 1040) ."

For example, if an individual earned $75,000 a year and had $5,000 in net capital losses for the year, the $75,000 income will be adjusted to $72,000 ($72,000-$3,000). The remaining $2,000 in capital losses can be carried over with no expiration to offset future capital gains.

What Are Basic Tax Planning Strategies?

Some of the most basic tax planning strategies include reducing your overall income, such as by contributing to retirement plans, making tax deductions, and taking advantage of tax credits.

How Do High-Income Earners Reduce Taxes?

There are many ways to reduce taxes that are not only available to high-income earners but to all earners. These include contributing to retirement accounts, contributing to health savings accounts (HSAs), investing in stocks with qualified dividends, buying muni bonds, and planning where you live based on favorable tax treatments of a specific state.

Can I Contribute to a 401(k), a Traditional IRA, and a Roth IRA?

Yes, you can contribute to a 401(k), a traditional IRA, and a Roth IRA. You must ensure that you only contribute the legally allowed amount per year. If you invest in both a traditional IRA and a Roth IRA, you cannot contribute more than the overall maximum allowed for an IRA.

Tax planning involves utilizing strategies that lower the taxes that you need to pay. There are many legal ways in which to do this, such as utilizing retirement plans, holding on to investments for more than a year, and offsetting capital gains with capital losses.

Internal Revenue Service. “ 401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000 .”

Internal Revenue Service. " Rev. Proc. 2022-38 ." Pages 8-9.

Internal Revenue Service. “ Rev. Proc. 2023-34 .” Pages 7-8.

Internal Revenue Service. " Publication 550: Investment Income and Expenses ." Page 56.

Internal Revenue Service. " Topic No. 409, Capital Gains and Losses ."

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Home — Essay Samples — Economics — Taxation — Analysis of Tax Avoidance and Tax Planning

Analysis of Tax Avoidance and Tax Planning

• Categories: Tax Taxation

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Published: Nov 8, 2019

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Essays in Tax Policy and Planning

• Spyridon Gkikopoulos
• Alliance Manchester Business School

Student thesis : Phd

• Short-Termism
• Productivity
• Vesting Equity
• Investments
• Irish Tax Havens
• Firm Valuation
• Corporate Tax Planning
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• Bonus Depreciation
• Risk-Taking

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Home > ETD > 2474

Theses and Dissertations (Comprehensive)

Three essays on the impacts of tax planning and earnings management on the informativeness of taxable income, book income, and cash flows from operations.

yong qiang chen , Wilfrid Laurier University Follow

Document Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Program Name/Specialization

Faculty/school.

Lazaridis School of Business and Economics

First Advisor

Advisor role, second advisor, third advisor.

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This dissertation comprises three independent but highly related essays that investigate the effects of tax planning and/or earnings management. The first essay investigates how high tax planning and/or aggressive earnings management affect the relative and incremental value-relevant information of taxable income, book income, and cash flows from operations (CFO). Regarding the effects of tax planning, first, I postulate and show that high tax planning reduces the relative and incremental information of taxable income to CFO. Second, high tax planning increases the relative and incremental information of CFO to the combined information set of taxable income and book income. Third, high tax planning also increases the relative and incremental information of CFO to book income. Concerning the effects of aggressive earnings management, I predict and show that the incremental information of CFO to book income and the combined information set of taxable income and book income, respectively, is increased for firms aggressive in earnings management. With respect to the combined effects of high tax planning and aggressive earnings management, I conjecture and find strong evidence that the relative and incremental information of CFO to either book income or the combined information set of taxable income and book income is increased for firms aggressive in both tax planning and earnings management.

The second essay examines aggressive earnings management, high tax planning, and their joint impacts on the persistence of book income and its components. First, I predict and show that aggressive earnings management reduces the persistence of discretionary accruals and thus the persistence of total accruals and book income. Second, I postulate and demonstrate that high tax planning reduces the persistence of CFO and thus the persistence of book income. Third, I find that, jointly, aggressive earnings management and high tax planning reduce the persistence of discretionary accruals and CFO and thus the persistence of book income. Finally, I demonstrate that firms aggressive in both earnings management and tax planning exhibit the least persistent total accruals, CFO, and book income.

The third essay investigates how tax planning affects the predictive ability of taxable income for firms’ future operating performance. Prior studies show that taxable income contains information about future earnings and positively predicts firms’ future performance. However, I postulate and find that high tax planning reduces the predictive ability of taxable income for future performance, which is proxied by one-, two-, and three-years-ahead CFO and book income. This finding suggests that investors should take into account the level of the firm’s tax aggressiveness when using taxable income to predict a firm’s future performance. In sum, the findings of this dissertation are of interest to both the accounting professionals and the capital market participants. Overall, this dissertation contributes to the earnings management literature and tax planning research.

Recommended Citation

chen, yong qiang, "Three Essays on the Impacts of Tax Planning and Earnings Management on the Informativeness of Taxable Income, Book Income, and Cash Flows from Operations" (2022). Theses and Dissertations (Comprehensive) . 2474. https://scholars.wlu.ca/etd/2474

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Tax Risks and Tax Planning

• Published: 13 October 2022
• Volume 42 , pages 954–957, ( 2022 )

Cite this article

• A. G. Boldycheva 1 &
• A. Yu. Klonitskaya 1  

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The role of tax administration in maximizing budget revenues at different levels is described. A significant proportion of tax payments consists of the settlement of arrears, as well as fines and penalties. These may be due to accountants’ errors or to deliberate tax evasion. The present work emphasizes the mutual interest of tax payers and tax collectors in tools for tax planning that balance an acceptable tax burden for businesses with an appropriate fiscal income for the state.

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Avoid common mistakes on your manuscript.

In most cases, the relationships of businesses and the state are mediated through taxes. Tax reform may be regarded as a permanent feature of national life. Historically, Russian tax laws in their current form have been under development since the 1990s. The state has been increasing the transparency of the business environment and strengthening tax administration.

Today, thanks to the digitization of accounting and auditing, tax administration in Russia has made notable progress. The development of risk management has considerably lowered the costs of auditing, while improving the quality. Correspondingly, fines and penalties have been growing, and the state has won many tax disputes.

The average income per tax audit has increased from 33.5 to 54.4 million rubles between 2019 and 2021, and continues to grow [ 1 ].

Note that, along with more stringent monitoring, the tax administration has expanded tax exemptions and preferences for individual categories of taxpayers, under specific conditions [ 2 ]. They have been expanded with particular vigor during the coronavirus pandemic, permitting many organizations to maintain financial stability and solvency.

Despite changes in the global economy that have changed market relations and transformed business activity, the main trends in Russian tax policies remain the same [ 3 ].

1. Suppression of the shadow economy. New administrative measures include the introduction of digital technologies and the creation of an integrated information space for tax regulation.

2. Expansion of inspections, with the introduction of new interim measures (seizure of property and freezing of accounts). Today, such measures are only employed after the decision that further investigation and auditing is necessary, in accordance with Article 101, paragraph 10, of the Russian Tax Code [ 4 ].

3. The right of the tax authority to collect funds from the taxpayer’s debtors. If the debtors resist, bailiffs may be summoned.

4. The right of the tax authority to seize certain of the taxpayer’s accounts and to draw funds from them against the payment of taxes.

5. Expansion of the reach of tax authorities beyond limited boundaries: no specific tax authority need be cited in regulating payment procedures and requesting documents.

These trends are evident in the conduct of tax audits according to Article 54.1 of the Russian Tax Code [ 4 ].

1. Verification whether transactions are truthfully represented or information regarding economic activity and the objects of taxation is distorted.

2. Tests for tampering with the budget and claiming unjustified tax benefits.

3. Identification of malicious intent: tax evasion, obtaining unjustified tax benefits, or knowledge of such behavior when concluding a transaction with a company conforming to the specifications in paragraph 6 of Letter N BV-4-7/3060@ (March 10, 2021) [ 5 ].

4. Verification of due diligence in the selection of a counterparty. That is the conventional standard for reasonable choice of a counterparty. The requirements include scrutiny of their business reputation, ability to fulfill obligations, and solvency.

These procedures force enterprises to select their tax policies more responsibly, since the consequence of errors may be substantial financial losses, calling into question the continued existence of the business and the personal liberties of management [ 6 ].

The tax authorities have the right to request documents in only three cases, according to Article 93 of the Russian Tax Code [ 4 ]: during a desk audit; during a check of a counterparty; and in collecting documents (information) regarding the taxpayer or information about specific transactions outside the scope of tax audits.

In a desk audit, the list of situations in which the tax authorities have the right to request documents is limited (Article 88 of the Tax Code) [ 4 ].

A taxpayer may also be invited to the tax office for an oral interview. Such invitations often follow failure to report taxes for two years or more; a low tax burden compared to the industry average; outstanding taxes and fines; employee salaries lower than the regional average in the industry; or relations with problematic counterparties.

Effective management of tax risks entails a comprehensive approach to the management of tax obligations. The goal is to discover and assess tax risks so as to decrease their likelihood or minimize the consequences of tax exposure.

Management of tax risks may be regarded as a cyclic process with the following steps.

1. Identification of tax risks. A useful tool here is the guidance for planning field audits in [ 7 ]: this document defines the criteria used by tax authorities in selecting targets for audits.

2. Analysis of tax risks so as to permit more effective tax management within a specific project, organization, or territory and at the state level.

3. Ranking of tax risks by importance and identification of risk management measures. Their significance is determined on the basis of their magnitude, and appropriate management responses are developed [ 8 ].

4. Implementation of risk management, with one-time analysis of the effectiveness of the financial responses.

5. Analysis of the results of risk management and improvements as necessary. This is the final step in independent risk assessment and permits the identification of deficiencies in the risk management system.

Unless it is aimed at finding unjustified benefits, tax planning within an organization is entirely legitimate. Tax benefits will depend on government policy (at the regional and municipal levels) and also on compliance with the specified terms.

In recent years, tax benefits have proliferated in response to the challenges of the coronavirus pandemic. Government also target tax benefits so as to promote specific activities. For example, since 2021, organizations involved with information technology (IT) have been granted economic stimuli, with relief not only from individual taxes but in the form of tax packages. Since 2022, public catering has been offered tax benefits.

Small enterprises may opt for four special tax programs [ 9 ].

1. Simplified taxation. This popular option (governed by Chapter 26.2 of the Russian Tax Code) permits payment of a single tax in place of VAT, property taxes, and income tax. Deductions from taxable income may be made for insurance coverage and sick leaves.

2. Patent taxation (covered by Chapter 26.5 of the Russian Tax Code). This option is only suitable for individual entrepreneurs.

3. Unitary agricultural tax (covered by Chapter 26.1 of the Russian Tax Code). This applies to agricultural entrepreneurs.

4. Tax on professional income [ 10 ]. This is an experimental program for individuals and freelance entrepreneurs.

Besides switching to one of these programs, another approach to tax planning is to divide obligations between interdependent companies by forming independent economic entities. This is not to be confused with illegal splitting of a business for purposes of tax evasion. Dividing financial flows between individual companies is legal and may decrease the tax burden if the goals, management priorities, pool of partners, assets, employees, and territories of the companies are not the same.

However, each company is unique. Consequently, no general criteria exist for classifying the subdivision of a business as legal or illegal. We have already mentioned the tax benefits offered to IT companies. Since IT departments are found in all large organizations, the idea of spinning them off as separate companies has been proposed. The Federal Tax Service has already ruled that no tax risks are associated with such splitting [ 11 ].

Tax-planning options at the local level include the creation of reserves for dubious debts, which may be counted as expenses when computing income taxes; depreciation premiums, which allow up to 30% of the purchase price of fixed assets to be taken as a one-time deduction; an investment deduction allowing certain extractive enterprises to take total expenditures on fixed assets as a deduction against income tax; and deduction of losses in previous years. Certain limits apply to the deductions for losses: for instance, the total deduction can be no more than 50% of the total taxable income.

Thus, the basic means of addressing tax risks are as follows.

1. Regular internal audits to verify the reliability of the accounts.

2. Due diligence in selecting counterparties.

3. Effective document management and distribution of responsibilities among staff.

INTERNAL AUDITS

Audits are required to detect and correct errors. Accounting errors may be fatal to companies. Audits allow management to survey all the existing risks and reserves, with relevant figures and reasoning, taking account of laws and current judicial practice. The auditors’ report confirms that all the necessary actions are being taken to comply with laws, rules, and standards of commercial behavior, and that the accounting practices are reliable; and that the laws regarding counterparties are observed.

At present, some auditing companies provide not only a report but expanded legal and financial guarantees of business, ensuring protection against tax claims; insurance against losses may be available, if required. If the authorities’ tax claims cannot be completely rebutted, all fines and penalties will be reimbursed.

DUE DILIGENCE

Each company is responsible for due diligence. The Federal Tax Service has set a certain standard of prudence in concluding transactions with counterparties. In this context, the following steps should be taken in scrutinizing counterparties.

1. Selection of a counterparty and request for all relevant documents and financial records.

2. Consultation of open sources (official web sites of the Federal Tax Service, the Federal Bailiff Service, the Federal Notary Chamber, etc.).

3. Consultation of specialized databases and additional sources: a certificate of workforce size to confirm the availability of labor resources, copies of lease agreements, property certificates, etc.

4. Market analysis and examination of similar commercial offers.

5. Creation of a dossier on the counterparty and assessment of the party’s business reputation.

A further safeguard is to include a tax clause in the contract [ 12 ]. This would indemnify the company against any losses incurred through the counterparty’s fault.

DOCUMENT MANAGEMENT

Careful document management reduces the risk of tax surcharges. Distribution of responsibility and power within the enterprise passes the responsibility for specific transactions from upper management to named individuals. The degree to which each individual has affected the outcome and conditions of the transaction is a key consideration here. The responsibility of each participant in the transaction must be fixed in internal job descriptions and other documents.

Management’s exposure to risk may also be decreased if internal company documents include clear statements of the circumstances and reasoning associated with each important decision—regarding the Covid-19 pandemic, for example.

Document management also entails monitoring of tax administrators’ primary concerns and implementing the following responses: (1) proof of the business goal of economic relationships; (2) proof that no tax benefit exists; (3) demonstration of the expediency of the production process and also commercial and final activity; (4) demonstration that all noted relationships actually exist and document management is subject to strict discipline.

Applying this check list to any company will avoid tax audits, disputes, and unnecessary expenditures.

As we have noted, the tax authorities offer specific benefits, such as the four special programs for small business and programs to support enterprises in specific regions and territories. Essentially, tax benefits serve to promote the economic development of the country and to create competitive market conditions. However, some enterprises try to misuse tax benefits in pursuit of competitive advantage. In most cases, a company will seek tax benefits by representing itself as a set of independent small enterprises. What are the legal limits of this maneuver? How can its economic expediency and business goals be proven?

On the one hand, enterprises legitimately use special conditions and tax programs, with economic benefit for the nation as a whole. On the other, the state seeks to curb abuses of those tax provisions.

To identify such abuses, the Federal Tax Service carefully analyzes the filings of taxpayers that create the appearance of several independent taxable entities in order to gain or preserve access to special tax programs that provide fiscal benefits. At the same time, the authorities strive to avoid unreasonable demands on businesses that have no felonious intent, since the choice of a business culture is the exclusive right of independent economic entities [ 13 ].

Successful economic development entails the organic collaboration of business and the state. That depends on clear rules and areas of responsibility. On a regular basis, enterprises should conduct audits and assess their own activity in terms of tax risks. For its part, the state, while tightening tax enforcement, will also offer more opportunities for managing tax obligations. Such a balance will foster the stable development of economic and legal relations within the country; reduce tension in the relations between tax authorities and tax payers; and create a favorable business climate.

Otchet f.2-NK Federal’noi nalogovoi sluzhby Rossii (Report f.2-NC of the Federal Tax Service of Russia).

Klonitskaya, A., Surkova, E., and Dmitrieva, S., Comparative analysis of the main elements of VAT taxation in the Russian Federation and Germany smart innovation, Syst. Technol ., 2022, vol. 275, pp. 291–298.

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Pis’mo no. BV-4-7/3060@ ot 10 marta 2021 g. “O praktike primeneniya stat’i 54.1 NK RF” (Letter no. BV-4-7/3060@ of March 10, 2021 “On the Practice of Applying Article 54.1 of the Tax Code of the Russian Federation”).

Skachko, G., Surkova, E., Ermolaeva, E., and Pocebneva, I., Adoption of management decisions on the basis of the risk management model, E3S Web Conf ., 2021, vol. 244, art. ID 11008.

Kontseptsii sistemy planirovaniya vyezdnykh nalogovykh proverok, utverzhdennoi Prikazom FNS Rossii no. MM-3-06/333@ ot 30 maya 2007 g. (The Concept of the Planning System for On-Site Tax Audits Approved by the Order of the Federal Tax Service of Russia no. MM-3-06/333@ of May 30, 2007).

Surkova, E. and Chaika, N., Cost management for quality of business processes, smart innovation, Syst. Technol ., 2022, vol. 275, pp. 349–358.

Tikhonov, A. and Zelentsova, L., Analysis of external and internal factors of business competitiveness, Qual.–Access Success , 2021, vol. 22, no. 182, pp. 16–19.

Federal’nyi zakon no. 422-FZ ot 27 noyabrya 2018 g. “O provedenii eksperimenta po ustanovleniyu spetsial’nogo nalogovogo rezhima “Nalog na professional’nyi dokhod” (Federal Law no. 422-FZ of November 27, 2018 “On Conducting an Experiment to Establish a Special Tax Regime “Tax on Professional Income”), Moscow, 2018.

Pis’mo FNS Rossii no. SD-4-2/3289@ ot 17 marta 2022 g. “O nalogovykh preimushchestvakh, ustanovlennykh dlya IT-biznesa” (Letter of the Federal Tax Service of Russia no. SD-4-2/3289@ of March 17, 2022 “On Tax Advantages Established for IT Business”), Moscow, 2022.

Grazhdanskii kodeks Rossiiskoi Federatsii, stat’i 431.2, 406.1 (Civil Code of the Russian Federation, Articles 431.2, 406.1).

Pis’mo FNS Rossii no. ED-4-2/25984 ot 29 dekabrya 2018 g. “O zloupotrebleniyakh nalogovymi preimushchestvami, ustanovlennymi dlya malogo biznesa” (Letter of the Federal Tax Service of Russia no. ED-4-2/25984 of December 29, 2018 “About the Abuse of Tax Advantages Established for Small Businesses”), Moscow, 2018.

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Boldycheva, A.G., Klonitskaya, A.Y. Tax Risks and Tax Planning. Russ. Engin. Res. 42 , 954–957 (2022). https://doi.org/10.3103/S1068798X22090064

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DOI : https://doi.org/10.3103/S1068798X22090064

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Tax Planning for Low-Income Taxpayers Research Paper

Tax benefits provided by government, tax planning, tax planning issues for small business and entrepreneurs with low income, influence by tax planning transformations 2008.

It is stated that the current Government is going to reverse the family trust changes introduced by the previous Government. The definition of family in the family trust selection regulations will be changed to restrict lineal successors to children or grandchildren of the test persons or the test someone’s spouse. This modification of the taxation system was represented in July 2008. Consequently, as Karl (2003) emphasizes “if a family trust was regarded as the trust which is aimed at making distributions to family that will be excluded from the test personal family group make sure it is before 1 July 2008. Family trusts will be prevented from performing a once off variation to the test personal specified in a family trust election (other than in relation to a marriage breakdown). Nevertheless this change will be retrospective from the viewpoint of the taxation rules of the 2007/08 income period”.

The government offers a tax program for families with children up to 13, and this program offers compensation of 35% of child care costs and up to $3,000 per child or dependent. As this tax credit is non-refundable, the families receive only the sum, which they have paid in taxes.

Fuller and Sharon (2002) state that New York State offers a refundable tax credit of up to 110 percent of the amount for which the families were eligible from the federal tax credit (whether or not they received it from the federal government). In contrast to the federal tax credit, the New York State child care tax credit is refundable so a very low income individual who does not have an income tax liability can still receive money .

The fact is that the opportunity for making all these variations off may be restricted, if not lost. These changes decrease the scope for family trusts for utilizing the possible tax losses and franking credits in order to decrease the income tax rate. The other changes of the Family Trust regulations were represented by the previous Government will not be invalidated entailing; permitting different variations in the family group that may happen as a result of death, divorce or birth and permitting family trust elections to be annulled in circumstances where the initial elections were not actually needed. Nevertheless, it is claimed by Fuller and Sharon (2002) that as a result of the tax-free threshold and low income offset taxpayers (other than minors) with income below $11,000 do not pay tax, consider ways of assigning income to any low income personalities in the family group. It is also necessary to emphasize that the threshold will increase to $14,000 for the 2008/09 tax year.

It is necessary to mention that when the employee leaves the service of the employer, one has an absolutely crucial decision to take. It is claimed that “ such worker is oblige to estimate and select whether he / she is better off leaving the retirement financial reserves in the current qualified 401k retirement pension plan (if it is allowed by the plan itself), changing the company’s qualified plan such as a 401k plan, or rolling over to an IRA, by way of an IRA rollover.” (Brown, Williams 2007). Originally, if this process is managed properly, the 401k rollover according to IRA, makes it possible to maintain tax-deferred status by qualified retirement funds. Consequently, the employee has an opportunity to avoid tax withholding (20%) and penalty for premature retirement.

The instances of IRA and 401k are given in Brown and Williams (2007). They emphasize the following fact: “with a rollover IRA the investment options are open to most all investments (tremendous rollover IRA advantage). Within a qualified retirement pension plan employee’s choices are usually restricted to the selections (maybe two or three dozen) made available within the company-sponsored 401k plan. IRA rollovers currently allow for the most flexibility regarding distribution options and beneficiary selection.” This, originally, can be highly valuable in regards to extending IRA multi-generational planning. The A 401(k) plan can provide numerous advantages for the low-income taxpayers. Originally, these advantages entail the possibility to decrease the tax rate, and also lowering if the taxable income, and making savings that accumulate without making deposits. Thus, in 1978 Congress decided to encourage the American population to save finances for their retirement. Originally, this was aimed to lower the federal taxes and enhance some additional income by decreasing taxes. The tax reform act, which originated from this decision, supported the elaboration of the tax-deferred savings program for workers. However, the first 401(k) program was launched in 1982. It was a “defined contribution” program that allowed any employer or employee to set up the sum of money, which should be directed to the fund.

As for the single mothers, it is necessary to emphasize that the Government has also elaborated the program, allowing them to reduce their taxes and gain untaxable allowances for raising children.

Chesser and Harrison (2003) in Journal of Accountancy claim the following: “ For the single mother to be eligible, one has to have earned income during the year, but beneath a particular level. This credit can add thousands to your tax refund and is a form of government-sponsored support for working single mothers. You can choose to have it show up directly in your paycheck the following year, instead of waiting for the end of year to file and receive the benefit”.

Taking into account the possibility to apply ROTH strategy instead of IRA, it should be stated that the biggest disparity between these two approaches is the way, the taxes are treated. (Traditional vs. Roth IRA: An Introduction and Comparison, 2009) If the yearly profits are $70000 and higher and $4000 are put in traditional IRA, the taxes will be paid from the rest $66000. Nevertheless, if these $4000 are put in traditional ROTH, these in no way will be regarded as the income tax deduction. Fuller (2002) in his turn states the following: “ The Roth IRA is going to make more sense in most situations. A person filing the taxes as single can not make over $95,000. Married couples are better off, with a maximum income of $150,000 yearly.”

As for the matters of tax planning which are aimed to simplify the tax system in general and not to bother people with the complexities of the bureaucratic system, it should be stated that the effective system is based on salary sacrifice. For clear understanding of the mechanism, it is necessary to cite Edward (2003) in his “Tax-Planning Services…” : “ An effective salary sacrifice system is based on the arrangement between the taxpayer and the employer detailing the exact salary rate or income which will be sacrificed. It is advised that the worker and the employer agree upon all the conditions of the wages forfeit arrangement. This arrangement should enter into force before the assignment is performed. Finally, the employer should not have any access to the salary being sacrificed for the period of the arrangement.”

Originally, the changes in the tax planning system touched deemed dividends allowing taxpayers not to apply to the Commissioner in case of their obtaining. It is said, that the permission for not applying to Commissioner was introduced to taxpayers to declare the dividends and get the tax credit for the future (Fuller and Kagan, 2002)

The companies are obliged to take into tax accounting the profits and losses which originate from their financial contacts, that reflect the generally accepted accounting practice (GAAP). There are two accounting tools regarded as authorized: mark to market (it is generally resorted to by financial traders) and accruals.

Business turnover lower $2 million means special tax benefits such as a simplified trade regime and tax offset. In case of advance income it should be compulsorily credited; there should be certain contributions to the political parties’ development for about $1,500. Investments in education and social funding should be compulsory observed. As Crouter and Booth (2004) found in their research: “ The earned income credit is a refundable credit for certain qualified workers. It is aimed at helping offset some of the increases in living expenses and social security taxes. This credit reduces the amount of tax owed, if any, and may result in a refund to the taxpayer.” From this point of view, the suitable workers may perceive some part of their income credit in their paychecks. For being suitable, the employee must have a child (under 18), and expect to fall into certain income restrictions, and meet other specific requirements. Which are generally stated in W-4 form, Earned Income Credit Advance Payment Certificate, and in more detail in Publication 596, Earned Income Credit, as stated by Crouter and Booth (2004)

From this point of view, the applying of examples will help in the issues of clarifying these strategies. Thus Perez (2009) states that by filling out any new form for the employer, any worker is free to make all the required adjustments for the withholding. As for the W-4 modifying, it is often emphasized that there is an opportunity to decrease the amount of the declared allowances according to line 5 of the W-4, or it may be done according to line 6: the wished amount for being withheld may be added. Garwood (2008) in his turn states the following: “ The more you have withheld, the more likely your tax bill will be covered and you will not owe money at tax time. In fact, you may benefit from a refund check. For those who are not very good at setting money aside for taxes, having more taken out of your weekly or biweekly paycheck is a benefit. ”

As for the rules of qualifying children for the aims of claiming the earned income credit, it should be stated that they are different from the rules for dependents. From this point of view it should be stated that it may be possible that a child may be qualified as the taxpayer’s dependent, but not for EIC; or would qualify for EIC. Here are the qualifying children rules for the earned income credit:

• Relationship test
• Residency test.

To claim a qualifying child or children it is necessary to attach Schedule EIC to Form 1040. (Perez, 2009)

It has been already emphasized that the threshold will increase to $14,000 for the 2008/09 tax year. Taking this into account it is necessary to state that such a threshold is aimed at increasing the possibility of giving tax credits, allowances and tax planning system capabilities. It is claimed that if such contributions are paid for the advantage of an associate, these contributions are regarded as fringe benefits. Consequently, where these contributions are paid to a non-accomplishing superannuation fund they will be regarded to be a fringe advantage.

Taking into account the tax-paying system for the low-income taxpayers, there are several filling status issues. Fuller and Kagan (2002) give 5 categories:

• Single. This is applied to everyone who is unmarried, divorced or separated by the state law.
• Married, applying jointly. A married couple may post a joint return. If a spouse died during the year, the other has an opportunity to file a joint return with that spouse for the year of death.
• Married applying separately. A married couple may elect to file their returns separately.
• Widow(er) with Dependent Child. A taxpayer is granted with an opportunity to choose this filing status if the spouse died during 2006 or 2007, a taxpayer has a dependent child and he o she meets certain other conditions.

This is regarded to be a strategy for married couples. If one of the spouses has a steady income and the other is a freelancer, the setting up of the withholding may be very helpful. Karl (2003) emphasizes that claiming for more withholding for any person with a steady salary will be really beneficial if the spouse who is an independent contractor has essentially higher earnings. This can be adjusted, should the independent working spouse have lower earnings, and can help ensure that they are covered at tax time.

Originally, if there is a strong necessity from the side of a taxpayer to make sure there is enough withheld to cover the tax obligations, any taxpayer does not want to have too much money withheld. This money may be invested and the attained profits may be derived from the interests.

Thus, based on these categories, the individuals having salary-packaged benefits and $180 000 or less taxable income are to review their sacrifice arrangements. Individuals with income lower than $11000 are not to pay tax – it is connected with low-income offset and tax-free threshold. The tax rate for minors (under 18 years children) make about 45%, the tax-free threshold is about $1,667, being increased to $2,667.

Another instance of married couple strategy tax-reducing may be applied in the case of one of the spouse’s death. Originally, it is stated that the NRB (nil-rate band) would result in a substantial IHT (inheritance tax) saving. However, this strategy has essentially changed since the transferable nil-rate band (TNRB) was represented on 9 October 2007 in the Pre-Budget Report. The instance of this strategy application is stated in Garwood (2008): “ For example, say John died in 1995 having used only 75% of his NRB. If his wife Mary dies in 2009, her NRB will be [pounds 325,000 (2009/10 NRB). This will be increased by the 25% unused proportion of John’s NRB so she has an NRB of [pounds] 406,250, thereby reducing the IHT on her estate by a further [pounds] 32,500. ”

In conclusion, it is necessary to mention that the opportunities provided by tax planning formation made some benefits to individuals with low income; though there are certain contradictions between state and federal policies striving to help such people.

Originally, the taxpaying structure for low-income taxpayers is essentially simplified, and, it is necessary to mention that they are granted lots of additional opportunities, which allow them to decrease the tax rate, decrease the threshold of the income tax and receive the tax credit, which is based on the social position, personal circumstances or working conditions which potentially may lead to the decreased income rates.

The strategies and systems which are widely represented in the paper offer different ways for declaring incomes, and depending on the way of this declaration, tax rates and allover sums vary. Originally, it is linked with the notion that citizens should have an opportunity to gain help from Government, on the other hand, this help is possible only if the taxes are thoroughly paid by all the citizens.

• Brown, Carol Necole, and Serena M. Williams. “The Houses That Eminent Domain and Housing Tax Credits Built: Imagining a Better New Orleans.” Fordham Urban Law Journal 34.2 (2007): 689
• Chesser, Delton L., Walter T. Harrison, and William R. Reichenstein. “Investment Tax Planning for Retirement: How to Make Taxes Work for the Client.” Journal of Accountancy 196.2 (2003): 63
• Crouter, Ann C., and Alan Booth, eds. Work-Family Challenges for Low-Income Parents and Their Children. Mahwah, NJ: Lawrence Erlbaum Associates, 2004.
• Fuller, Bruce, Sharon L. Kagan, Gretchen L. Caspary, and Christiane A. Gauthier. “Welfare Reform and Child Care Options for Low-Income Families.” The Future of Children 12.1 (2002): 97
• Garwood, Paul. “Financial And Tax Planning, Summer 2008 – Maximising Your Returns.” Mondaq Business Briefing, 2008
• Karl, Edward. “Tax-Planning Services for Clients or Employers: CPAs Should Understand Their Responsibilities.” Journal of Accountancy 196.6 (2003): 69
• Perez, William. “2009 Tax Rate Schedules. Tax Brackets for the 2009 Tax Year” Tax Planning: U.S. 2009
• “Traditional vs. Roth IRA: An Introduction and Comparison”. Flexo, 2009.
• Chicago (A-D)
• Chicago (N-B)

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NB: This post is a student essay, not personal / professional tax advice. Whilst everyone’s circumstances are unique, there is a common objective for most people who have a high net worth to want to maximise investment return whilst minimising tax liability. Would you not agree? Well you can tailor your investment strategy to meet your objectives through; utilising Allowances and Exemptions, using Tax Efficient Investment Wrappers to ensure that your investments work hard for you whilst mitigating Capital Gains and Inheritance Taxes to protect more of your estate for the benefit of your loved ones. Pensions We all know and understand that pensions have the benefit of providing for us in retirement however, what about using your pension contributions as a valuable tax planning tool? Pension contributions as part of tax planning can be used to mitigate personal allowance tax traps as well as Bond and Capital Gains Tax. Please be aware that any calculations shown are on a UK basis. Maximising Tax Relief: You receive tax relief on private pension contributions worth up to 100% of your relevant annual earnings. Relevant earnings are broadly earnt income and do not include pension or dividend income. Tax relief is given automatically if you are a basic rate tax payer or you are paying into a workplace pension and the contribution is taken before deducting income tax. You will have to claim tax relief if you pay income tax above 20% through your self-assessment tax return for 20% if you are a 40% tax rate payer and 25% if you pay tax at 45% if your pension scheme automatically only collects 20%. Reclaiming Tax Relief: For anyone earning over £100,000 for every £2 above you will lose £1 personal allowance (tax year 2018/19) and this continues until all your personal allowance is gone. With an income of over £123,700 (tax year 2018/19) all the personal allowance is lost. Case Study Mr Smith has an income of £110,000 and so has lost some of his personal allowance. By making a pension contribution of £8,000 net, £10,000 gross he has increased the amount of tax free income through the reclaimed allowance and has also pushed out the basic rate band. As a result, he has saved £4,000 in tax and received relief in the pension of £2,000 this is an effective rate of tax relief of 60% and giving him a pension pot of £10,000 as illustrated below. Reflection on income distribution Reflection on Income and tax bands Mitigating Bond Taxation Whenever a chargeable gain arises on an investment bond it is assessed for income tax purposes. Putting it simply any gain is divided by the amount of full years that the bond has been held to determine what is known as the ‘slice’. The slice is then added to your income to determine if there is any tax liability. If the bond is an onshore bond and you remain in the basic rate band then there will be no tax liability as the bond is assumed to have paid basic rate tax within the fund. However, should you fall fully into the higher rate band then a further 20% tax is due and within the additional rate band this would be 25% due. In principal, with planning, by calculating the amount needed to move some or all the slice into a lower tax band and then make a pension contribution in the same tax year that the bond gain is taxed you have now moved the slice and income into the basic rate tax band. By doing so you have now reduced the tax payable thus increased bank balance and created an increased pension fund. Confirming that a pension contribution can be a very effective method of negating higher rate tax on the encashment of investment bonds. These principals work similarly for pension contributions for net pay arrangements and for offshore bonds. Mitigating Capital Gains Tax Capital Gains Tax (CGT) is the tax charged on the capital gain, profit, that is made on the disposal of an asset. The profit is considered to be taxable income. CGT rates changed on the 6th April 2016 reducing from 18% to 10% for non and basic rate tax payers and 28% to 20% for higher and additional rate tax payers (Except in relation to gains accruing on the sale of residential property that do not qualify for private residence relief). When the gain is calculated it is added to the top of your income and will include any slice on bond gains. As described earlier your basic rate band is increased by any grossed up personal pension contribution. So again, by calculating the amount needed to move some or all the gain into a lower tax band and then make a pension contribution in the same tax year that the capital gain is taxed your pension contribution will now have pulled all the income at higher rates of tax into a lower rate tax band. By doing so you have now reduced your tax liability and created an increased pension fund. With careful planning the relief would be greater than the tax payable on the gain. These principals work similarly for pension contributions paid gross as they reduce the taxable income. (www.pruadviser.co.uk) Investment Bonds Investment bonds can be highly tax efficient investments. They are life insurance policies that allow you to invest in a variety of available funds to meet your attitude to risk. Investment bonds are not deemed to be income producing assets which means that investors and/or trustees do not need to complete self-assessment tax returns. Funds within a bond can be switched without giving rise to CGT and reinvested income does not give rise to income tax. Bonds can also be assigned unlike ISA and Pensions. You can take 5% withdrawals of the original capital and they will be regarded as return of capital rather than income. Top slice relief can be used on chargeable gains move you to a higher tax bracket, as described earlier. Bonds can be taken out on multiple lives unlike ISA and pension investments and can be placed in trust and removed from trust without an Income Tax charge or CGT. With both onshore and offshore bonds available choosing the right bond for you is very important. The table below shows a comparison of the Tax treatment for each. ONSHORE OFFSHORE Tax on Income No further tax payable on a chargeable event above 5% unless you are a higher or additional rate tax payer After 5% cumulative withdrawals the highest marginal rate of tax is payable on a chargeable event. Tax on Capital Gains Nil Nil Investment bonds are often used for inheritance tax planning in conjunction with the following types of Trusts, many of which can be set up on either an absolute or discretionary basis. A brief description of trust types is listed below: • Discounted Gift Takes part of the investment bond out of the Estate immediately. You have to take an income and the rest of the investment becomes exempt to inheritance tax after 7 years. • Gift and loan (or loan-only) The investment bond falls out of the Estate as the loan is repaid, typically at 5% per annum. More suitable for those with a life expectancy of at least 20 years. • Interest in Possession Suitable for beneficiaries who require an income with the capital paid, often to another beneficiary, at the end of the term or a predetermined age. • Retained interest A portion of the investment bond is gifted to named beneficiaries and the other part is held for the benefit of the Settlor. • Excluded Property Suitable for UK resident non domiciled individuals who can exclude an offshore investment bond from being liable to UK Inheritance Tax. • Will Trusts A wide variety of trusts can be written in a will with gifts into trust to take place after the death of the Settlor. These can be codified in a will or written posthumously using a Deed of Variation. If no will is in place trusts can be defined by the laws of Intestacy and a bond must be written in a statutory trust. • Lifestyle Trusts Lifestyle Trusts are a form of Discretionary Trust where distributions can be made to beneficiaries at future dates for predefined amounts. The Settlor can continue to access capital and the bond would fall outside of the estate after 7 years. After 7 years the trust would continue to be subject to the standard charges for a discretionary trust. Deciding on which trust to use for an investment bond depends on a variety of factors, such as wanting to be able to change the future beneficiaries, access to capital and/ or income and the domicility of the bond owner. (www.investment-bond-shop.co.uk/trusts-inheritance-tax-planning) Individual Savings Account (ISA) ISA wrappers are extremely tax efficient savings vehicles as they are not subject to income tax or capital gains tax. The current ISA allowance is £20,000 per annum. The junior ISA allowance is £4,128 and is available to children under the age of 18. You can have any number of different types of ISA however, you can only pay into one of each type each tax year and by investing across your ISA savings you have to ensure that you do not go above the annual allowance. For example, if you have a cash ISA, a Stocks and Shares ISA and an Innovative Finance ISA and you put £3,000 into your cash ISA, £4,000 into your Innovative Shares ISA you would have £13,000 left of your annual allowance to invest. The ISA has evolved over the years and there are now several different types available to invest in. Here is a quick overview with pro’s and Con’s. 1. Cash ISA Pro’s -Low risk way to save tax efficiently. Withdraw cash when you need to and both fixed and variable rates available. Con’s- low interest rates mean low savings growth. 2. Stocks and Shares ISA Pro’s – No UK income or capital gains tax. Freedom to invest in line with your attitude to risk. Withdraw money when you need to. Potential to grow money over the longer term. Con’s – Risk of losing money as you are investing in the stock market. Withdrawing money may not be immediate. 3. Innovative finance ISA Pro’s – No UK income or capital gains tax. Withdraw money when you need to. Potential to grow money over the longer term. Con’s – Not covered by the Financial Services Compensation Scheme (FSCS). Risk of losing money as you are investing in the stock market. Withdrawing money may not be immediate. 4. Lifetime ISA Pro’s – Save towards a first home or retirement (must be opened between age 18-39, although payments can continue until age 50). Receive up to £1,000 free per annum from the government. Con’s – Restricted eligibility age. Strict rules on what you can withdraw money for and when without paying a penalty. Flexible ISA Rules New rules for a flexible ISA were published in 2016. These rules came into place to allow investors to withdraw funds and replace them without having an impact on annual subscription limits. This gives you added flexibility without losing out on your annual allowance. It should be duly noted however, that offering flexibility is optional for ISA Managers and is not available in the Junior or Lifetime ISA. Estate Planning Should an owner of an ISA die on or after 6th April 2018 then the ISA will retain its tax-advantaged status during the estate administration period. Ensuring spouse and civil partners will also be entitled to subscribe additional amounts to their ISA, equal to the amount of the deceased’s ISA at the point that it is closed. This is only available up to three years until the date of death. Investments ISA contributions can be invested into various assets. These include life insurance policies, gilts, authorised unit trusts and shares in open ended investment company (OEIC’s). You can also invest your ISA into company shares that are eligible for enterprise investment schemes (EIS), venture capital trusts (VCT) and business property relief (BPR). An overview of these latter asset classes is covered below. In addition to this if you have stocks and shares outside of your ISA wrapper then you can cash them in and make use of your capital gains tax limit and then ‘bed and ISA’ them. It should be noted that the anti-avoidance rules do not apply if you buy back the same stocks and shares through your ISA wrapper. As you can see it is well worth, due to their tax efficiency, taking advantage of the generous limits available each tax year. Alternative Investment Market (AIM) Formed in June 1995 as a sub-market of the London Stock Exchange. It allows shares in smaller companies to float shares more flexibly than the main market and helps fledgling companies to grow and develop to the main market. It is often overlooked or dismissed by mainstream investors. Although not for the fainthearted there are many benefits to investing in an AIM listed company. Here is a summary of the main benefits available: • Business Property Relief (BPR) – 100% Inheritance Tax Relief for those who qualify although, the investment must be held for 2 years. • Enterprise Investment Scheme (EIS) – Listed companies provide 30% initial income tax relief on investment, exemption from CGT on disposal and loss relief. There is also a CGT deferral by reinvestment limited to income tax relief for the year. • Venture Capital Trust (VCT) –For listed investments there is an exemption from tax on dividends and CGT and there is a 30% Income Tax relief on the amount invested. • ISA – In August 2013 AIM listed companies were allowed to be included in Individual Savings Accounts. Encouraging longer term investment by providing shelter from IHT, CGT and Income Tax. • Relief for losses – If an investment fails or disposed at a loss, based on the tax payers tax rate, losses can be relieved against the gains in the year or subsequent year or against income in the year or prior year. • 0% Stamp Duty – Certain companies that fall under the growth market are exempt from Stamp Duty and Stamp Duty Reserve Tax. • Entrepreneurs relief – Investors owning at least 5% of a company for over a year may be eligible to reduce their CGT to 10%. Business Property Relief (BPR) Business property relief can be extremely valuable, especially if you want to pass down your wealth to your loved ones. BPR came into legislation in 1976, it is an inheritance tax relief provided by the government to encourage you to invest in certain types of companies. These types of investments do tend to be riskier however, the tax relief is designed to offset some of this risk and motivate you to invest into companies that might not be as attractive as mainstream investment options. If you own shares in qualifying BPR companies on your death these shares are passed on to your beneficiaries free of IHT, if you have held the shares for at least two years. Holding investments in BPR is just like investing in any other type of shares, which means, unlike other forms of estate planning you retain ownership of your investment for your lifetime. It is an investment held in your name and should you need access to it at any time you can sell the shares. However, you do need to be mindful that it may not be as quick and easy to sell as other investments. A BPR investment is likely to be higher risk and more volatile. The benefit of this tax relief will depend on your own personal circumstances and should be part of a wider strategy. BPR has been part of the UK tax legislation for over 40 years however, like any legislation it could change in the future. HMRC will assess every claim individually including whether the underlying companies that you invest into qualify for BPR when you die. Because of this it is not possible to guarantee that an investment that you make will qualify for relief in the future. Enterprise Investment Scheme (EIS) Enterprise Investment Scheme (EIS) was launched in 1994 to encourage private investment into early stage unquoted companies. Its success has been credited with the introduction of the Seed Enterprise Investment Scheme (SEIS), which specifically targets companies in their first two years looking to raise their first £150,000 in funding. Following the introduction of EIS, Michael Portillo, then Chief Secretary to the Treasury said:- “The purpose of Enterprise Investment Schemes is to recognise that unquoted trading companies can often face considerable difficulties in realising relatively small amounts of share capital. The new scheme is intended to provide a well-targeted means for some of those problems to be overcome.” (www.enterpriseinvestmentscheme.co.uk) Again, investing in these types of scheme tends to be riskier however, for the investor it is a tax efficient way to invest in small companies with the ability to utilise a ‘carry back’ facility where investments can be applied to the proceeding tax year. With an EIS 30% tax relief can be claimed on investments up to 1 million in one tax year if you have enough Income Tax liability to cover it. You can also invest up to £100,000 into SEIS. The shares must be held for at least 3 years from the date of issue or the tax relief will be withdrawn. An attractive feature is that any gain is CGT free if the shares have been held for at least 3 years and the Income Tax relief was claimed on them. If you hold these types of shares they are normally held for longer time frames which then enables you to accrue your CGT exemption over a longer period. If the shares are disposed of at a loss you can elect that the amount of losses, less Income Tax relief given can be set against income of the year in which they were disposed or income of the previous year instead of being set against any capital gains. Payment of CGT can be differed when the gain is invested in shares of an EIS qualifying company. The gain can be made from the disposal of any kind of asset however, the investment must be made one year before or three years after the gain arose. If as an investor you are connected to the company, you are not eligible for Income Tax relief. Connections are defined through financial interest or employment to the company. It should also be noted that tax relief will be withdrawn if the company loses its qualifying status. Case study examples of scenarios Mr Smith, who is a 45% Tax payer, has invested £10,000 in an EIS company and has held the shares for over 3 years. The company has done well and doubled its value. Investment = £20,000 Income Tax Relief = £6,000, as a reduction in Mr Smith’s income tax bill. Capital Gains Tax = £0 Mr Smith’s gain = £16,000 (profit + income tax relief) The company value remains the same. Investment = £20,000 Income Tax Relief = £6,000, as a reduction in Mr Smith’s income tax bill. Sale of Shares = £20,000 Mr Smith’s gain = £6,000 (from income tax relief) The company close and the shares are worthless. Investment = £20,000 Income Tax Relief = £6,000, as a reduction in Mr Smith’s income tax bill. At risk capital = £14,000 Loss relief on capital at risk @ 45% = £6,300 Mr Smith’s actual loss = £7,700 (£20,000 – [£6,000 + £6,300]) The availability of tax relief on EIS and SEIS investments is dependent on individual circumstances and the company concerned. It is important that you recognise that these can change in the future. Venture Capital Trust (VCT) Venture Capital Trust were launched in 1995. VCTs are companies that are listed on the London Stock Exchange that invest in other companies that are not themselves listed. They are classed as a closed-end collective investment scheme designed to provide capital for smaller expanding companies as well as income and/or capital gains for investors.

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Essay on Tax Planning

Tax planning and minimization is extremely important for all types of business, since these processes allow to ensure that appropriate revenues are kept in business and invested in further operations. The process of tax planning includes review of previous financial results, forecasts of taxation for the next period of time used in the company’s accounting system, and application of different financial vehicles for minimizing taxes as well as selection of appropriate tax minimization strategies.

Income tax minimization

• Section 162 of Internal Revenue Code (Trade or business expenses) allows to reach a tax reduction for the “ordinary and necessary expenses paid during the taxable year in carrying any trade or business”
• Transportation expenses can also be written off
• Equipment depreciation can be used to deduct taxable income value (depreciation allowance)
• Section 179 allows to perform annual purchases of equipment (limited by a given sum) which are tax deductible

Capital gains tax minimization

• Capital gains can be offset and balanced with capital losses
• Publicly traded stocks allow to put off paying the capital gain (the stock should not be liquidated earlier than within 1 year after the purchase in order to reduce capital gains tax)
• Equity investments reduce capital gains tax
• 1031 exchange allows to exchange one investment property to another (within 180 days) without having to pay capital gains tax

Estate tax minimization

• Estate tax credit can allow estates below a given value ($1 million) to pass through federal estates taxes
• Limited partnerships or LLCs can transfer the assets to other entities as limited partnership interests, thus getting a discount between 20% and 50% of the estate value
• Charitable gifts are not taxed as well
• Trust accounts can be used to minimize estate taxes

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Essay on Tax Planning Letter

Introduction

A trust refers to a fiduciary relationship, which grants a third party (a trustee) a mandate of holding assets on behalf of beneficiaries. There are numerous ways in which trusts can be arranged specifying when and how should the assets pass onto the beneficiaries. There are two main types of trust: revocable and irrevocable trusts. The former refers to trusts created by individuals that can be altered, revoked or amended. The latter, on the other hand, refers to trusts created by an individual that cannot be altered, revoked nor amended.

In this case, the client desires to establish an irrevocable trust for his grandchildren. In particular, he wants the income from the tax to be paid to the grandchildren for twenty years. He also wants the income from the trust to be paid to the grandchildren after the twenty years.

The main issue, in this case, pertains to the effects of an irrevocable trust on future estate taxes and gift taxes. There is also the issue of maximizing the potential advantages of the payment of gift taxes on the transfer of property. There is also the issue of the alternatives that the client can use to reduce estate tax.

Applicable Authority

The applicable authorities to the client’s situation are the Tax Payers’ Relief Act of 2012 and the case law of  Crummey vs. Commissioner  (from which the technique of Crummey powers is derived).

Evaluation of Authority

The Taxpayer’s relief act of 2012 allows individuals in the USA to transfer their assets as substantial gifts that are exempted from the federal transfer of assets taxes. The taxpayer’s relief act of 2012 states that individuals will be exempted from tax if they transfer their property in the form of gifts. However, the worth of the property transferred as gifts should not exceed $5.25 million. Otherwise, the federal transfer of property taxes will apply. Besides, if an asset is transferred to another party as a gift, its appreciation value is exempt from tax. Notably, the acts allow each trust beneficiary to receive an annual income of up to $14,000 that is exempt from tax. However, an annual income of over $14, 000 is taxable. The Taxpayer’s relief act of 2012 also offers an exemption on real estate of up to $5.25 million.

Although transfers to irrevocable trusts are generally not subject to estate tax, they are subject to the gift tax. However, beneficiaries can qualify for the yearly gift tax exclusion provided they have full control over the gifts. However, this is not the case in the client’s situation. In  Crummey vs. Commissioner,  the court held that the annual gift tax exclusion would apply in instances where the beneficiaries to the trust have a right to withdraw gift to a trust. The annual gift tax exclusion applies even in cases where the beneficiary does not exercise his/her right to withdraw the gift from a trust.

Conclusions and Recommendations

Based on the findings from the preceding section, the client can establish an irrevocable trust for his two grandchildren. However, he should ensure the value of the assets he transfers to the trust does not exceed $5.25 million lest taxes apply. Through this, each of the grandchildren can receive an annual income of up to $14,000 that is tax-free. Besides, the appreciation value of the trust would not be taxed.

The client can also activate the annual gift exclusion by granting the beneficiaries the right to withdraw to trust. The client can send a letter to the grandchildren, informing them that they have a right to withdraw to the trust. This will qualify them for the annual gift tax exclusion. Overall, the transfer of property through irrevocable trusts assists one in minimizing the estate taxes.

Crummey v. CIR , 397 F.2d 82 (9th Cir. 1968).

The Taxpayer’s Relief Act 2012

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