For individuals and corporations, one aspect of overall financial planning is tax planning. As much as a majority of people may want to wish away their tax liabilities, it remains an integral component of modern living. To ignore the significance of tax systems to persons or businesses is to lose sight of the fact that in many countries, taxes eat up as much as a third of the population’s generated income.

Nations in general depend on taxes for the survival of their respective economies. More than half of the countries in the world have Gross Domestic Products that are fueled by taxation – at least a quarter up to 50% (and in some cases even more) of their GDP consists of revenue from their various taxes. This clearly illustrates the crucial role of taxes in public finance, which has direct implications for personal and corporate finance as well.

In light of this, tax planning makes a lot of sense. Taxes impact not only individual finances but entire economies as well. Paying attention to existing tax laws and looking out for opportunities to improve ones financial situation through various acceptable tax mitigation schemes is a vital part of keeping ones finances viable.

Tax Planning Defined

One way to define tax planning is to highlight its expected results – that is, tax planning is the adoption of legal measures that would reduce the total payable tax due. Although eliminating tax altogether may be the desire of most taxpayers, it remains an elusive dream.

Tax reduction is the key concept here. Lowering ones exposure to tax is at the very core of tax planning. This used to be a simple matter. There was a time when tax planning merely involved determining what to spend on, when to make the purchase and whether such expenditures are tax deductible.

These days however, new forms of tax relief have evolved as well as more sophisticated strategies for tax reduction to the extent that professional expertise may be needed for most cases in order to achieve an optimal and legal tax plan. Such experts may include accountants, tax lawyers, registered financial advisers and professional tax planners. Some specialized computer programs even help to maximize tax savings.

Aspects of Tax Planning

One irrefutable principle in tax planning is that the more you earn on paper, the more exposure you have to tax liabilities, and therefore the more taxes you pay. Chances are, the reverse is also true – the less you earn, the lower your tax liabilities.

The challenge, therefore, in tax planning is to reduce one's exposure by lowering the documented taxable income as well as availing oneself of various tax reliefs to further reduce the total tax owed. It may sound simple enough, but there is no shotgun approach that can be applied to the process. Everything must be done on a case-to-case basis.

The foundational requirement for tax planning is a thorough knowledge of applicable tax laws. If your accountant has minimal exposure to the intricacies of taxation in your particular locale, that puts you in a less than ideal position to take advantage of tax planning. Obtain the best services from a real tax expert and endeavor to become familiar with the tax laws applicable to you, as well.

For individuals, there are not too many lawful options to reduce income on paper. This is further confounded by the particular tax laws of the relevant domicile of the taxpayer. In some cases, individual taxpayers may avail themselves of various deductions to the taxable gross income which may include contributions to a retirement fund or other tax deductible annuity investments.

Business owners, on the other hand, have more expenses which may reduce their gross taxable income. In many countries, small businesses and self-employed persons are allowed greater latitude of adjustments to their gross revenue.

Another aspect of tax planning is the accounting method used by businesses. The cash method of accounting allows businesses to delay billing of customers in order not to increase taxable income. In contrast, the accrual method of accounting may allow the posting of larger deductions for billed expenditures.

Large corporations usually have no choice in this regard, as most jurisdictions require accrual accounting for large business entities. The option here is to time deductible expenses towards the year’s end. Smaller businesses, on the other hand, may opt for cash accounting and then defer the collection of receivable income until the following year. In both cases, tax savings will be realised.

Lastly, tax planning also involves utilisation of various forms of tax relief provided by laws of the particular jurisdiction of the taxpayer. Such tax relief may include various tax exemptions and, additional tax deductions, as well as tax credits. Advanced tax planning will include the use of a wide array of financial and legal structures, both onshore and offshore, that would effectively minimise the taxpayer’s exposure to tax.