What Is Tax Planning and Why It Is Important
A common notion with tax planning is to minimize the tax liability, in reality, it is a broader aspect of the total financial management. Individuals and businesses alike, need to harmonize tax planning with their financial strategies to reap the best rewards.
In an evolving and ever-changing business market, the role of the CPAs and tax planners has become multi-faceted. For example, tax planning requires a comprehensive financial management approach rather than number crunching and accounting record-keeping.
Off-course that doesn’t mean undermining the importance of financial and accounting records accuracy.
What is Tax Planning?
For individuals and businesses alike, the financial aspect of tax planning remains similar. Compliance with regulatory authorities and minimizing tax liability remains an important objective to achieve.
The rapid evolution of accounting function with embedded technology and matured concepts like virtual accounting services means businesses now expect a broader context of advisory from their tax planners.
The empire of tax planning will build on strong accounting and financial records. Accurate and compliant financial records will lay a strong foundation for the client’s financial strategy.
Moreover, tax compliance regulations don’t change overnight, but the implications often change in different scenarios.
For example, the current pandemic caused recession has compelled regulatory authorities to amend several tax relaxations such as deferral of employee social securities or change in charitable donations.
Here are some key areas that modern tax planners and advisors must address with their clients.
- Advice on Entity Structure and type with tax implications
- Corporate or Income tax liabilities
- Tax credits and deductions
- Backing tax deductions with accounting records
- Managing the tax-brackets for the clients effectively
- Multi-year tax planning with a strategic approach
- Addressing the impacts of choices with Sources of finances, Employee Retirement plan contributions, and investments
Tax Obligation Management
Tax obligation management primarily concerns the identification and payments of all business taxes. Arranging the funds and managing the tax returns timing also play an important role in tax obligation management.
For businesses, tax obligation management will include:
- Managing Business (or self-employed) taxes including Income tax, Sales tax, Employment taxes, Excise taxes, local and state taxes.
- Managing funds for tax payments e.g. on monthly, quarterly, and annual tax obligations
- Filing the federal income tax returns with accurate income tax forms
- Tax relief and deductions with compliance
Importance of Tax Planning
You may need to plan for tax liability minimization, filing the right form, and providing accurate details on Schedule C for the cost of business operations. After all, the main purpose of tax planning is to pay whatever you due to the government (but not more than that) and to stay compliant with regulatory requirements.
In addition, you may seek last-minute advice from your tax planner on the year-end tax-saving tips, but if you plan ahead of time, you’ll make the most out of the resources. Every financial and strategic aspect of the business incurs tax implications.
Also, remember, your personal and business tax liability is directly linked. In a sense, your business tax planning will also affect your personal wealth management and retirement plans.
Here are a few key areas of your personal and business financial management, where effective tax planning may make things easier for you.
Business types and Tax Liability
It will primarily include the entity type and the effects of “pass-through taxes” on your annual tax liability. For example, a C corporation, an LLC, or a Partnership to incorporate as the filing entity.
The question isn’t a straightforward one though. It will also depend on how you plan to fund and operate the business.
Business Expenses and Deductions
Your direct business expenses will get reported on Schedule C to determine the business income. Business accounting records back that filing and the resulting income decides your tax bracket.
However, numerous tax deductions legally can reduce your tax liability burden.
- Research and Development costs of business
- Investing in green energy
- Asset depreciation and Amortization
- Maximizing the employee retirement contributions
- Business use of home and other personal assets
- Net operating Losses carry over
Cost of Financing and Taxes
You can fund business with either Equity or Debt. Interest paid on loans is tax-deductible, but a higher debt ratio means costly bank loans. The balancing of the financing structure directly implicates the tax management for your business.
Retirement Contribution and Savings
You can start an individual retirement plan such as a simple IRA and start investing in other saving plans to start with. Effective tax planning can bring you more benefits with a wiser retirement plan selection.
Also, you can contribute towards your retirement plan as an employee of your own business. Some retirement plans offer more contributions than simple IRAs or Roth.
For example, with an FSA plan, both you and your business employees can contribute but it comes with a maximum contribution limit.
The HRA for your employees (including yourself) will require only employer contribution without any limit. Let’s talk about it with some other options for your long-term savings and retirement plans.