From the course: Accounting Foundations

What is tax planning?

From the course: Accounting Foundations

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What is tax planning?

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- Okay, now we're going to talk about tax planning. Let's begin with a quote. This is from U.S. Judge Learned Hand in 1947. "Over and over again, courts have said that "there is nothing sinister in so arranging one's affairs "as to keep taxes as low as possible. "Everybody does it, rich or poor, and all do right, "for nobody owes any public duty "to pay more than the law demands." Taxes are enforced exactions, not voluntary contributions. Here's another quote, this one from Supreme Court Justice John Marshall Harlan II in 1965. "The tax law exists as an economic reality "in the businessman's world, "much like the existence of a competitor. "Businessmen plan their affairs around both, "and a tax dollar is just as real "as one derived from any other source." Also, perhaps you're familiar with the saying, "A penny saved is a penny earned." In the spirit of these quotes, when we teach business analysis, we always tell our students, "A tax penny saved "is the same as an operating penny earned." Now, is it ethical to arrange one's affairs so as to keep taxes as low as legally possible? Well, of course it is. We can refer to the Goldilocks principle of income taxes. You don't want to pay too little income tax. You don't want to pay too much income tax, pay just the right amount of income tax. But what if you're a civic-minded person, want to pay more? Well, all governments are happy to accept voluntary contributions. Consider this quote from the Treasury Department of the United States. "Citizens who wish to make a general donation "to the U.S. government may send contributions "to a specific account called 'Gifts to the United States.'" In 2024, the total amount donated was $2,785,754.76. That donated amount was enough to pay the interest on the outstanding US government debt for one minute, 19 seconds. (groans) Well, what we're going to talk about now is tax planning. Tax planning is structuring your activities to pay the minimum amount of tax that is required by law. Not too much, not too little, but just right. We'll talk about basic tax planning strategies. It turns out that all complex tax planning strategies are a combination of three basic strategies. First, shifting income from one time period to another. Usually, tax payers wish to delay the taxation of income. That's the reason for the shifting. Second, shifting income from one pocket to another. Taxpayers wish to shift income from a high tax state or country to a lower tax state or country. And the third common tax strategy, is to change the character of the income, or the rate at which income is taxed. We previously discussed the difference between ordinary income and capital gains income. Capital gains income is typically taxed at a lower tax rate. So, transforming ordinary income into capital gains income is another basic tax planning strategy. We'll talk about each one of these three basic tax planning strategies.

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