A business or individual may engage in tax planning in order to alter the amount of taxable income to be recognized in a particular tax period. This is typically done to take advantage of a tax credit or tax loss that will otherwise expire if it is not used now.
Here are several possible tax planning strategies:
- Defer a deduction. If there are tax deductions that can be legitimately deferred, this can increase the amount of taxable income in the current period.
- Recognize interest income. Set a policy for recognizing interest income on a receivable basis, which can accelerate the recognition of this income from when it would otherwise be recognized upon the receipt of cash.
- Sell assets. If an asset has appreciated in value, sell it now to recognize a taxable gain. This approach only works if the tax basis of the asset has not been adjusted upward.
- Swap assets. If an asset does not currently generate taxable income, swap it for an asset that does.
As an example of how tax planning is used, Entwhistle Electric has a $25,000 net operating loss carryforward that is due to expire at the end of the current tax year. Entwhistle elects to sell several machines that have appreciated in value, which will generate a taxable gain of more than $25,000. The net operating loss can then be used to offset this gain before the NOL expires, thereby reducing the company's tax burden.