Tax Planning Startegies Overview

Posted on June 22, 2024

CORPORATIONS' TAX PLANNING STRATEGIES

Corporations, like other taxable entities, often seek to minmize the tax paid to governments in order to retain cash for:

• Internal investment
• Shareholder payouts
• Debt payments
• Other purposes- such as acquisitions

COMMON STRATEGIES CATEGORIZED AS BELOW:

• Timing: When is incomeor loss recognized ?
• Income-Shifting: To whom/where is income or loss allocated?
• Estimated payments and the avoidance of underpayment penalties: Eliminating unnecessary penalty payments.

In addition to these strategies, corporations must be aware of limitations generated by nontax business contions as well as certain judicial doctrines in order to implement the most effectives tax planning practices.

TIMING STRATEGIES: The idea behind timing strategies relies heavily on the concept of the time value of money.

• Timing strategies are a type of tax planning that pertains to:
• when income must be recognized;.
• when a deduction or loss can be taken;
• when a tax credit is allowed.
• To be effective, the corporation must have the ability to influence the timing of income, loss, deduction or credit items.
• In line with the time value of money, timing strategies work to:
• maximize the after-tax cash inflows(income); or
• minimize the after-tax cash outflows(deductions) associated with a decision.
• With timing strategies, it is particularly important to first recognize whether the strategy involves income or deductions because the tax strategies are different in each situation.

Effective tax planning with Deductions:

• Effective tax planning works by maximizing after-tax income or minimizing after-tax deductions.
• The tax costs (savings) are determined by multiplying the associated income(deduction) item by the corporation's marginal tax rate.
• In order to maximize after-ax cash inflows(income) and minimize after-tax cash outflows (deductions), effective tax planning involves the following:
• Minimizing tax costs (as a means to increase after-tax income)
• Maximizing tax savings (as a means to decrease after-tax deductions)

Effective tax planning with Tax-Credits:

• Tax credits reduce tax liability dollar-for dollar.
• As such, corporations should typically seek to use as much value in tax credits as soon as they become available in order to reduce tax liability more quickly.

The timing strategies work by moving the recognition of an income, loss, deduction or credit between two or more tax years, by shifting it to an earlier or later period.

When considering timing strategies, the three most relevant variables are:

• the amount of the income/deductions;
• the applicable marginal tax rate; and
• the discount factor (is relevant when postponing income is considered).

FORMULAS

Pretax income * Marginal tax rate = Tax costs * Discount factor = Present value of tax costs

Pretax deduction * Marginal tax rate = Tax savings * Discount factor = Present value of tax savings

GOAL OF TAX PLANNING

The goal of tax planning is to:

• minimize the present value of the tax costs (which maximizes after-tax income)- in other words- try to pay your taxes later and
• maximize the present value of tax savings (which minimizes after-tax expense)-in other words- try to take deductions sooner to pay less taxes now.
• consider the discount rate on items that are postponed.

Assuming the firm has a positive rate of return on investments, the discount factor is always less than one, meaning that it reduces the present value.