Tax Planning: Definition, Types and Techniques

As a conscious citizen, everyone has a responsibility to pay taxes regularly. However, not everyone is liable to do that. One should only pay taxes if their income is taxable. Tax planning is the art of minimizing tax liability by making the best use of the available tax benefits.

Planning of tax is a way to analyze one’s financial situation from a tax saving point of view. It is a legitimate way to reduce one’s tax liabilities in a financial year.

It can save your annual earnings from eating up by tax by utilizing tax exemptions, deductions, and benefits the authorities offer. It is is the best possible way to minimize one’s liability.

It confirms the legal obligations of the Income Tax Act, 1961, while saving tax. Also, mitigates one’s tax burden and helps in saving money. There are various advantages of setting up tax.

There is always friction between the tax collectors and the taxpayers. The tax collector wants to extract the maximum amount possible while the payer tries to keep their tax liability to the minimum. Tax planning resolves the disputes with the tax authorities viz local, state, federal or foreign tax authorities.

It helps you arrange your investments within the benefits offered under the Income Tax Act, 1961, thereby reducing your payable tax. The act has provided many tax planning schemes to reduce your tax liability and save money.

Effective tax planning is a way to allow a healthy inflow of white money in the country. The money paid as tax is utilized to better the country, which is necessary for the excellent progress of any country.

Tax planning is a magnificent way to channelize funds from taxable sources to income-generating plans. The planning objectifies the utilization of funds for productive causes.

The various types of tax planning are:

This type of tax planning is practised at the end of the financial year, and it promotes substantial tax savings without partaking long term commitments. To limit their tax liability, investors usually search for short-term tax planning at the end of the financial year.

A long-term planning does not offer immediate tax benefits but proves exceptionally beneficial in the longer run. The plan marked at the beginning of the financial year needs is followed throughout the year by the taxpayer.

Indian Income Tax Act, 1961 offers several tax planning provisions such as deduction, exemption, contribution, and incentives for tax planning to save money. For example, tax-saving instruments offer various deductions under section 80C of the Income Tax Act, 1961.

Purposive tax plans ensures optimal benefits from investments. It involves accurately selecting the investments, creating a schedule, diversifying assets, and replacing assets if needed. This method of tax planning uses tax-saver instruments.

The most optimum way of saving taxes is by sticking to your financial plans, even if your income is revision. Making tax-saving investments at the beginning of the year is always better rather than making hasty investment decisions at the last moment. Indian Income Tax Law has various sections that offer tax deductions and exemptions. Income Tax Act, 1961 provides several options to the taxpayers to reduce their tax liabilities.

The six basic principles around which all tax-saving techniques revolve are:

1. Splitting Income: By shifting income among the family members helps in getting more of the income taxed at lower rates

2. Shifting Income: Shifting certain kinds of income like bonuses and year-end payments from one year to another lowers the earning so it could be taxed at lower rates.

3. Shifting Deductions: Opting to pay deductible expenses by moving them from one year to another enables you to place them in a place where tax benefit could be maximum.

4. Deferring Tax: Making certain investments or pension plans allows you to wait for taxes until the future.

5. Tax-exempt Investments: Always select investments that produce income exempted from either federal or state income tax, or both.

6. Tax-deductible Expenditures: By meeting specific requirements in the Tax Code, certain expenses may be tax-deductible. An example of this tax-cutting technique is, structuring your affairs to obtain a tax deduction by stringent IRS guidelines.

Income tax planning is an intelligent decision that is entirely legal and should follow the framework defined by the respective authorities. Adopting shady ways to save taxes is illegal and might land you in legal trouble. Prudent plans of tax is everyone’s responsibility. You can always choose from various tax saver mutual funds and investment avenues based on your choices, tax slabs, and social liabilities.