Objectives and Methods of Tax Planning

Tax planning is an activity that enables you to reduce your tax liability. It is one of the most basic yet integral parts of the financial plan, and it helps you save your capital. Several options enable taxpayers to reduce their tax liabilities, especially those that fall under Section 80C of the Income Tax Act of 1961.

Under this section of the IT Act, you can claim tax deductions of ₹150,000 on various kinds of investments such as tax-saving fixed deposits, PPF contributions, EPF contributions, Unit Linked Insurance Plans (ULIPS), and National Pension System, among other things. Here’s everything you need to know about tax planning objectives and methods, especially if you are a first-time taxpayer.

Objectives of tax planning

First-time taxpayers must understand the fundamental objectives of planning their taxes. They are as under:

To reduce tax liability: Tax planning primarily revolves around reducing your tax liability. Every single taxpayer wishes to reduce the burden of paying the taxes while saving their money for their future. Fortunately, the Government offers several different investment schemes through which liabilities can be reduced significantly. However, it is essential not to leave tax planning to the last moment. Plan to invest in tax-savings instruments from the beginning of the financial year and avail all the advantages to reduce your tax payments.

To minimise litigation: Minimising legal litigations is essential while planning taxes. If you don’t have one, you must avail the services of a legal advisor. Consult your advisor and adopt the adequate provisions of tax planning laws, so that you can minimise the litigation. Minimising litigation saves you from judicial harassment.

To stabilise the economy of the country: The taxes you pay are devoted to the betterment of the country. If you pay all the taxes which are legally due, you can contribute towards creating a more productive economy. Planning your taxes is beneficial for you and the economy of the country in which you’re living.

To leverage productivity and financial growth: Planning your taxes prudently can facilitate economic growth for you. Chalking out clear and precise financial objectives from your investments, over specific time frames and investing in the right tax-saving instruments can help you create a good corpus, thereby contributing to your economic growth.

Different ways in which you can plan your taxes

While most people think of tax planning as a process that helps in reducing their tax liabilities; it is also about investing in the right instruments, at the right time, so that you can achieve your short, medium and long-term financial goals. Fundamentally, there are four varied methods of tax planning. They are as under:

Short-range tax planning: This is a term used in reference to tax planning that is both, though of and executed when the financial year comes to an end. Investors resort to this planning on the heels of the end of the fiscal year, attempting to find ways to reduce their tax liabilities legally. For instance, if, at the end of the financial year, assesses find that their taxes are high as compared to the previous year; they may want to reduce it. Assesses may be able to do that by adequately arranging to get tax rebates under Section 88. Short-range tax planning does not involve long-term commitments, while it still can promote substantial tax savings.

Long-range tax planning: The long-range tax plan is one chalked out when the financial year begins, and which the taxpayer follows throughout the year. Such an arrangement may not provide immediate tax-relief benefits as short-range plans do but can prove to be beneficial in the long run. You typically have to start investing when the new financial year begins and hold on to the investment for a period exceeding one year.

Permissive tax planning: Permissive tax planning, as the term suggests, means planning investments under various provisions of the taxation laws of India. In India, there are many provisions of law, offering exemptions, deductions, incentives and contributions. Section 80C of the Income Tax Act of 1961, for instance, offers several different types of exemptions (on the amount invested, interest earned and the amount at maturity) on tax-savings investments.

Purposive Tax planning: Purposive tax planning refers to the act of planning investments with specific purposes in mind, thereby ensuring that you can avail maximum benefits from your investments. It involves the accurate selection of investment instruments, creating a suitable agenda to replace assets (if necessary) and diversification of income and business assets based on your residential status.

Tax Planning Issues

Check on Congress. The most important thing you can do this year for your tax planning is to keep an eye on Congress to see whether lawmakers manage to extend popular tax provisions before the end of 2015. Some notable provisions must be extended in order to allow:

Taxpayers aged 70½ and over to make tax-free charitable contributions from individual retirement accounts (IRAs);

Businesses to deduct up to half of eligible equipment placed in service this year;

Teachers to receive an above-the-line deduction for $250 in classroom expenses;

Students and parents to receive an above-the-line deduction for tuition expenses;

Companies to receive a credit for qualified research expenses; and

Taxpayers in states without an income tax – like Washington, Texas and Florida – to deduct state sales taxes.

Document your business activities. You may not need to pay a 3.8 percent Medicare tax on your business income if you participate in the business enough so that you are not considered a “passive investor.” Participation is almost any work performed in a business as an owner, manager or employee as long as it is not an investor activity. Even so, you must document your activities, and the IRS will not let you make ballpark estimates after the fact. Make sure you document the hours you’re spending with calendar and appointment books, emails and narrative summaries.

Prepare your information reporting. You should start gathering information early this year to make sure you can complete your mandatory reporting on time. Congress has enacted new legislation that more than doubles most penalties for late or incorrect information returns. This includes the Form W-2 employers must provide to all employees and the Form 1099 a business must provide to any contractor it pays at least $600 for services. These returns are due to recipients by Feb. 1 and the IRS soon after.

Get your charitable house in order. If you plan on giving to charity before the end of the year, remember that a cash contribution must be documented in order to be deductible. If you claim a charitable deduction of more than $500 in donated property, you must attach Form 8283. If you are claiming a deduction of $250 or more for a car donation, you will need a written acknowledgement from the charity that includes a description of the car. Remember, you cannot deduct donations to individuals, social clubs, political groups or foreign organizations.

Remember your state and local tax obligations.

Don’t forget that state and local governments impose their own filing and payment responsibilities with various income, sales and property taxes. Recently, states have become more aggressive in taxing corporations that are not physically present in their states, but have significant sales to customers in those states.  While there may be exceptions for limited business activities in particular states, it is wise to check on your activities of your salespeople that often travel to different states to ensure you are filing all state corporate tax returns as needed.

Take a closer look at your state residency status.  For individuals who split their time in two different states throughout the year, now is an excellent time to consider where you may be taxed as a resident for 2015. To make it more likely that the high-tax jurisdiction will respect the move and not continue to tax you as a resident, you should track the number of days you are spending in each jurisdiction. Generally, if you reside in a state for 183 days or more, that state will assert residency and the ability to tax all of your income. Furthermore, if you move to a new state but you maintain significant contacts with the old state (including driver’s license, residences, bank accounts and the like), you could run the risk of being taxed as a resident in the old state.

What problems and opportunities are created by tax havens?

Tax havens have attracted increasing attention from policy-makers in recent years. This paper provides an overview of a growing body of research that analyses the consequences and determinants of the existence of tax-haven countries. For instance, recent evidence suggests that tax havens tend to have stronger governance institutions than comparable non-haven countries. Most importantly, tax havens provide opportunities for tax planning by multinational corporations. It is often argued that tax havens erode the tax base of high-tax countries by attracting such corporate activity. However, while tax havens host a disproportionate fraction of the world’s foreign direct investment (FDI), their existence need not make high-tax countries worse off. It is possible that, under certain conditions, the existence of tax havens can enhance efficiency and even mitigate tax competition. Indeed, corporate tax revenues in major capital-exporting countries have exhibited robust growth, despite substantial FDI flows to tax havens.