Effective Tax Planning
by
Charles Lamson
By keeping good records and thinking about tax implications of financial transactions, you make tax planning a key ingredient of your overall personal financial planning. The overriding objective of effective tax planning is to maximize total after-tax income by reducing, shifting, and deferring taxes to as low a level as legally possible.
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Keep in mind that avoiding taxes is one thing, but evading them is another matter altogether. Do not confuse tax avoidance with tax evasion, which includes such illegal activities as omitting income or overstating deductions. Tax evasion, in effect, involves a failure to fairly and accurately report income or deductions, and, in extreme cases, a failure to pay taxes altogether. Persons found guilty of tax evasion are subject to severe financial penalties and even prison terms. Tax avoidance, in contrast, focuses on reducing taxes in ways that are legal and compatible with the intent of Congress.
Fundamental Objectives of Tax Planning
Tax planning basically involves the use of various instrument vehicles, retirement programs, and estate distribution procedures to (1) reduce, (2) shift, and (3) defer taxes. You can reduce taxes, for instance, by using techniques that create tax deductions or credits, or that receive preferential tax treatment---such as investments that produce depreciation (such as real estate) or that generate tax-free income (such as municipal bonds). You can shift taxes by using gifts or trusts to shift some of your income to other family members who are in lower tax brackets and to whom you intend to provide some level of support anyway, such as a retired, elderly person.
The idea behind deferring taxes is to reduce or eliminate your taxes today by postponing them to some time in the future when you may be in a lower tax bracket. Perhaps more important, deferring taxes gives you use of the money that would otherwise go to taxes---thereby allowing you to invest it to make even more money. Deferring taxes is usually done through various types of retirement plans, such as IRAs, or by investing in certain types of annuities, variable life insurance policies, or even series EE bonds (U.S. savings bonds).
The fundamentals of tax planning include making sure that you take all the deductions to which you are entitled and take full advantage of the various tax provisions that will minimize your tax liability. Thus comprehensive tax planning is an ongoing activity with both an immediate and a long-term perspective. It plays a key role in personal financial planning---in fact, one of the major components of a comprehensive personal financial plan is a summary of the potential tax impacts of various recommended financial strategies. Tax planning is closely interrelated with many financial planning activities, including investment, retirement, and estate planning.
*SOURCE: PERSONAL FINANCIAL PLANNING, 10TH ED., 2005, LAWRENCE J. GITMAN, MICHAEL D. JOEHNK, PGS. 119-121*
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