Importance of Tax Planning - Essay Example

Tax Planning Tax planning is an important element for a business; it is the structuring of transactions with the intent reducing tax costs and gaining tax benefits. Strategic tax planning is a common occurrence in the business world because of its ability to help companies maximize their after-tax value. Businesses need tax planning to help implement strategies that would lessen their tax liabilities for the year ahead. There are numerous tax planning strategies available to business owners. Regardless of how simple or how complex a tax strategy is, it will be based on structuring the business transactions to accomplish anyone or more of the following goals: 1) reducing the amount of taxable income, 2) reducing the tax rate , 3) claiming any available tax credits, or 4) controlling the effects of the Alternative Minimum Tax. Tax avoidance is the process of planning business transactions in a manner that legally minimizes the amount of taxes due. The four maxims of tax planning are built around the premises of helping businesses work around tax liabilities. 1) Businesses turn over profits to entities that fall within lower tax rates. Reducing tax liabilities can be accomplished through both shifting income to lower-tax rate entities and shifting deductions to higher-tax rate entities. 2) Shift taxable income to a later time period as, in present value terms, tax costs decrease and cash flows increase when the liability is deferred to a later taxable year. This should be done taking into consideration the opportunity costs involved due to shifting income to another year as well as the possibility of tax rate changes in the following year. 3) Due to the differences in state and country laws, it is possible to gain tax advantage by shifting income to a lower-rate tax jurisdiction. This opens up planning opportunities of tax planning for companies which have global presence. 4) By shifting income from business activities to more tax-favored instruments like government bonds, companies can take advantage of preferential tax rates. Businesses, therefore, arrange transactions in such a way that income is shifted to heads which are subject to preferential tax rates. Tax planning thus requires the researcher to consider all fields of income generation and the entity, jurisdiction, time and character of income. An important aspect of tax planning is tax research. Tax research is required to determine the tax consequences of a transaction, either before or after the transaction is done. In case of a closed-fact transaction, the facts surrounding the transaction are recorded and hence, can no longer be subject to the client's control. Conversely, an open-fact transaction is one which the business is proposing to undertake and hence is subject to the client's control. In such cases, a tax adviser can help create facts to support the transaction that will help them influence the tax consequences of that transaction. The role of the tax researcher is to determine the optimal business decisions that its client firm should make, as they relate to tax. When the tax consequences for a firm differ among decision alternatives, tax researchers help to identify the most optimal course of action for management to make in order to maximize their after-tax income. Tax research is a six step process that encompasses all activities required by a researcher to understand the transaction and gather data to support it. The first step involves a thorough understanding of the business transaction and the facts surrounding it. It is important for a tax researcher to acquaint himself with the non-tax features of the transaction before moving onto the tax implications. Once the researcher is done analyzing the non-tax features of the transaction; he moves onto the second step, which is identifying the tax issues suggested by the transaction. The identification of issues lead to formulation of tax research questions. The third step involves the most important component of tax research, which is locating the relevant authority to provide answers for the research questions. Today, electronic libraries are gaining prominence over traditional book-shelf libraries due to speedy access to sources, ease of updating current developments and portability. The tax researcher should know how to locate the references pertaining to the problem using both primary as well as secondary authorities. Primary authorities, such as the Internal Revenue Code, Internal Revenue Service, Department of Treasury and so on, provide citations which can support the facts surrounding the transaction. Secondary authorities explain the tax laws for a layman to understand and interpret and point in the direction of the relevant primary sources. Researchers should be well equipped to search required sources to find answers for the research questions already formulated. On finding the relevant authority to support the transaction, the researcher then has to interpret and evaluate it. The researcher can do so based either on factual judgement or evaluative judgement. At this stage, if the researcher finds that all facts necessary are not gathered, he repeats the entire process until satisfied with them. The final step is to document the research by preparing a permanent record for future references and communicate the findings to the client through a letter explaining the conclusions drawn. Evaluating Tax Research Sources The IRS is an agency within the U.S. Department of Treasury and issues a number of guidance which are published in the Cumulative Bulletin updated every week in their website. The rulings and procedures issued by the IRS serve as primary sources for tax researchers. When conflicts arise between taxpayers and IRS, they are settled in courts and the decisions rendered by the courts serve as sources; and these can be searched within the website using keywords pertaining to the transaction in question. FASB issues accounting guidance that companies have to follow in their accounting procedures. FASB aims to establish and improve standards of financial accounting and reporting so as to provide guidance to companies as well as readers of the financial reports. The FASB website provides a Technical Inquiry Service where researchers can browse for existing FASB literature. Federal Tax Law Research website acts as a secondary source for researchers to locate analyze and better understand tax laws and also provide links to the primary authorities to support the conclusions. One can search within the website using keywords and extensive search tools to arrive at previous documented cases. It provides links to the materials located in the Harvard Law School Library. This guide also provides information on databases within CCH Tax Research NetWork and RIA Checkpoint, online services available through the Harvard Law School Network and at many law firms. Ethics in tax planning Every businessman indulges in finding the best ways to lessen his tax burden. The taxes levied by the government are used to fund the activities of the public sector in providing welfare, security and infrastructure to the citizens. The degree to which citizens approve this facility and ideology of the government would determine their attitude towards tax planning. Tax planning, like tax evasion, enables the citizens to escape their moral obligations of paying for the social costs of the community. The only difference between the two being the legality involved; tax planning is legal, tax evasion is not. There are many ethical issues involved in the tax planning exercise. There are some who believe that it is a fundamental right for every citizen to avail all tax incentives provided by the Government in reducing tax liability. Some say that it is unfair of taxpayers to intentionally look for ways to take advantage of the tax system. Some others argue that it is unjust for businesses with resources to employ professionals to identify ways of manipulating tax. In a business environment, there is often the option of completing a taxable transaction by more than one method. The courts normally back the right to choose the course of action that will result in the lowest legal tax liability. This course of action, which is perfectly legal, is called tax avoidance. Tax avoidance involves legal exploitation of tax laws to an advantage so as to reduce the amount of tax payable. Examples of tax avoidance include using tax deductions, changing tax status, moving business to a low tax jurisdiction and so on. By contrast, tax evasion is the attempt to evade taxes by illegal means such as deceit, subterfuge, or concealment. Tax evasion involves a taxpayer deliberately misrepresenting or concealing facts so as to reduce his tax liability. IRS identifies the areas where fraudulent behavior is most noticed: 1) failure to report substantial amount of income, 2) claims for improper or fictitious deductions, 3) accounting irregularities and 4) improper allocation of income to individuals in lower tax brackets. In the United States, tax evasion is evading the payment of a tax that is already legally owed at the time of the criminal conduct. Tax avoidance on the other hand, is a lawful conduct aimed at avoiding the creation of a tax liability. Ethical considerations come into play while evaluating various methods of reducing tax. Irrespective of the sophistication or the ingenuity which makes tax evasion possible, it creates innumerable moral problems that have to be dealt with. While both tax evasion and tax avoidance aim to reduce tax liability, tax evasion is tuned towards illegal aspects and hence is more ethically incorrect. The IRS keeps a keen track of businesses and their tax planning through Tax Law Doctrines. While doing tax planning, business must ensure that transactions are realistic and not faulty facades and transactions must have a business purpose other than just tax avoidance. References Financial Accounting Standards Board. April 29, 2007 from http://www.fasb.org Harvard Law School, Federal Tax Law Research. April 29, 2007 from http://www.law.harvard.edu/library/services/research/guides/grfs/specialized/tax.php Internal Revenue Service, United States Department of Treasury. April 29, 2007 from http://www.irs.gov Read More