Tis the season of tax….albeit the longest tax season ever (thanks COVID). The benefit of doing it earlier in the year is we have the snapshot of the prior year earlier so we can plan for the upcoming year.
A lot of people and businesses feel a little panicky around tax filing. They worry, is it tax planning, or are they somehow engaging in tax evasion – which is a criminal offense! Using the tools available to you is tax planning, avoiding the rules in place is tax evasion. Keep reading to help you grasp some important concepts that will ease your mind with taxes forever.
1. What is Tax Planning?
When you analyze and arrange your financial situation so that it minimizes your tax liabilities and maximizes your tax breaks in a manner that is completely legal and fully efficient.
Basically, it means to have a thorough, close-eyed look at your assets and finances to see if you have labelled them rightly. Then going through the actual tax laws and rules to see if you are correctly categorizing and paying your tax.
Some common strategies for tax planning include your income being deferred or if you’re a business owner incorporating your business, maximizing or deferring your retirement contributions, your capital losses or gains, ownership of property, charitable contributions etc.
Laura incorporated her business Company LMN Inc. This company had a profit of $20,000. Laura wants to also save for her future and invest. She opens up investments by the corporation and invests the profits.
During tax filing, she wouldn’t have to pay extra taxes! Why? That’s because she did not take the money out of her corporation to invest. Assets can grow in the corporation without being taxed as long as they aren’t taken out. This is helping you plan for your retirement and defer taxes – As she is the sole shareholder, the growth of the company eventually benefits her personally.
Most people take out the profits of the company and use it to invest personally; as a result she would be paying unnecessary tax. Now, due to tax planning, she can keep her money and let it grow!
2. How can you do Tax Planning?
Tax is a compulsory payment to the government. Every individual or business is bound by tax laws. These laws have many provisions. Some of them are known as allowances, deductions, exclusions, exemptions etc.
You don’t need to know every single component of tax laws. But what you do need is, to have a discussion about your finances with an accountant who can work together with you in a tax-efficient manner. This will reduce your total tax bill.
If you have investments, then you can work with your accountant to strategize your investments with tax-exempt securities. You could also time the sale of your capital assets to maximize your tax benefits. The benefit of a firm like Dharna CPA is that because we do both accounting and financial planning you don’t have to have multiple people playing broken telephone about your finances.
3. How does Tax Planning help you?
Tax planning has a lot of benefits for your short-term and long-term finances. Taxes are a regular part of your yearly expenses. Planning them correctly will help you minimize your tax burden.
Here’s how tax planning will change your financial life for the better:
1. Reduces your tax burden by using strategies within the tax laws.
2. Takes away the yearly stress during tax filing. A proper plan taken at the beginning of a tax year will allow you to pay correct taxes without mental stress of “am I doing everything I should be?”.
3. With tax planning, you avoid paying unnecessary tax without breaking the laws. This allows you to have more money in your pocket.
4. When you follow strategies of tax planning, you overcome the impulse to evade tax altogether.
4. What is Tax Evasion?
Tax evasion is financial fraud. Organizations, trusts and individuals illegally avoid paying taxes to the tax authorities.
They do so by misrepresenting the true state of financial affairs deliberately.
Actions of tax evasion include dishonest reporting of tax, declaring less income, presenting wrong values for profits and gains than actually earned, or writing off more deductions than is legal etc.
During tax filing, Susan claimed a $1000 deduction as a charitable donation to her local orphanage. It was not a registered charity nor did they issue a receipt.
She also decided that the rent from her villa in France needn’t be reported while filing her taxes. She felt that since the income was from overseas, so why should it be mixed with her income here?
Susan also felt that her newly bought BMW for her personal use could also be written off as a business expense. After all, she did make a couple of business trips in this car. She kept no records and claimed 100% of her car expenses.
She apparently evaded tax for a while. Later on, the tax authorities caught up with her fraudulent methods of avoiding tax. She received a hefty fine which resulted in her paying more money than if she had correctly paid her tax. WHY? because the interest and penalties are calculated from the year of filing, not when you are caught.
5. How to know if you are Evading Tax?
There is a big difference between avoiding tax through planning strategies legally and evading tax using wrongful methods.
“The difference between tax avoidance and tax evasion is the thickness of a prison wall.” — Denis Healey
Sometimes, you may unintentionally misreport your finances while tax filing which may result in tax evasion.
You may have income coming in from overseas assets. And you may think they aren’t taxable because it just doesn’t make sense apparently. Unfortunately ignorance of the rules does not excuse the results; therefore it is very important to have an open conversation with your accountant about all the assets you have, the activities you are engaged in, and the proper tax treatment. Then a proper tax strategy can be implemented.
Since tax laws are quite vast and complex, you may not be familiar with some of its components relating to your financial situation.
Many entrepreneurs, small businesses and gig economy workers aren’t well versed with tax laws that pertain to them. In their ignorance, they may unintentionally fail to present the exact picture of their finances while filing taxes.
The best way to avoid falling in default whether intentionally or accidentally, is to consult with an accountant. We at Dharna CPA, analyze your financial situation and provide tax filing advice to legally plan your taxes and avoid defaulting or evasion.
What happens if you evade tax?
Tax evasion is considered a felony. The repercussions for tax evasion include anything from a fine to jail time, depending on various factors. In the long run, this hurts your business standing and reputation. It’s therefore always safe to plan your taxes beforehand and avoid trouble with tax authorities.
We provide help with your taxes right from the start and are always by your side. You can book a free consultation with us, and from then on, we shall help you ease your mind with taxes, every year.