Tax planning definition
/What is Tax Planning?
Tax planning is the development of a strategy for minimizing or delaying an entity's tax burden within the structure of its financial and operational plans. The result can be a reduction in the effective tax rate paid, leaving more cash for other purposes. Several tax planning strategies are noted below.
Time Your Income Generation
If you know that you will be subject to a different income tax rate next year, then work to alter the timing of your income between this year and next year, to take advantage of the rate change. For example, if you expect the tax rate to decline next year, then defer as much of your income this year as possible. Conversely, if you expect your tax rate to go up next year, then try to shift more of your prospective income into the current year. This concept is especially applicable if you have the ability to issue billings to clients at the end of the year, or wait and bill them in the following year.
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.
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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.
Example of Tax Planning
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.