“The refund was higher than expected because your income was taxed at a flat 15 percent.” Wouldn’t that be good to hear from your tax advisor? The nature of complex tax planning, and good tax planning is indeed fluid, however, there are staple strategies to endure and should be used as a platform for creating a tax plan that reduces taxes paid currently, annually and even for a lifetime.
Below are five tax policies that can be followed from year to year and should also act as guideposts in applying tax law.
Structure business and personal affairs to take advantage of tax laws:
The structure of a business enterprise, such as legal ownership and type of entity chosen, can have a profound affect on the taxation of the business earnings and the worth of the business. The proper structure can also enable better tracking of costs and expenses that generate tax credits. Having a separate credit card or checking account for exclusively business expenses can keep deductions from being missed.
Take advantage of lower tax brackets:
The rate of tax on income is dependent on the character of that income. The decision can be made to structure transactions to create income eligible for the current low capital gain rate of 15 percent. In addition, the assets of a portfolio can be specified to generate higher taxable income when there are more deductions to offset it. This is business planning, with the effect of tax costs in mind. It is important to think symbiotically with business and taxes.
Calculate the effective tax rate on income:
This is simple – know what is paid in taxes. Every year, the total tax expense is divided by total net income, which calculates an effective tax rate percentage or amount of every dollar paid in taxes. Using the first two policies to reduce the effective tax rate percentage automatically frees up dollars to re-invest. It’s like found money and compounded over time can add up to years worth of earnings.
Calculate the efficient tax rate on income:
This is the next step after calculating the effective tax rate – determining when to recognize taxable income. For example, is it better from a tax standpoint to sell an asset this year or next? Depending on the situation, it may be more beneficial, or efficient, to pay some taxes early rather than waiting, because the tax rates may go up. This policy looks at the big picture by calculating taxes over time based on current and estimated future income.
Calculate adjusted net tax worth:
Net worth has two deflators – inflation and taxes. Although there is not much that can be done about inflation, tax expense can be controlled to increase net worth. Just a couple of percentage point’s reduction of taxes can increase net worth substantially. Annual net worth should be calculated with taxes in mind because net worth is eventually taxed and it appears that it is going to stay that way.
These five policies can be used to implement an effective tax strategy. They are not only very powerful when working together; they will also endure through the multitude of tax law changes taking place now and in the future. By calculating the percentage of each dollar that goes toward taxes, when that tax is paid, and how it affects net worth, a strategy to track performance is put into place. The lawful reduction of tax expense equals money and more net worth – that is great performance.