What Is Personal Tax Planning All About?

Personal tax planning is the process of looking into different options so one can determine when, how, or whether to conduct personal transactions that in effect will reduce taxes, if not totally eliminate them. If you want more information how to do this right, read on and learn.

Normally, a taxpayer has the option and power to complete a taxable deal by more than a single method. Choosing one that will subject him or her to less tax isn’t going against the constitution. In fact, the law backs it up. This means that it’s OK to look for ways on how to lower your taxes. You can even avoid some of them if you want.

Now, hold on a second. Don’t get the idea that tax evasion is right, OK? Remember that the word avoidance has a completely different meaning with the word evasion. To avoid paying taxes, you come up with legal and sensible ways on how to cut down the total amount you have to pay. To evade though, is to reduce the amount by concealing some details deceitfully. That said, you can gather that what makes an evader is his or her fraudulent intent on paying (or not paying) taxes.

The following are the most common signals of evasion:

1. Failure to include some substantial amounts of income- Appropriate income tax planning involves the inclusion of ALL the income you receive at a particular tax period. If you fail to report some of them, like a shareholder omitting his dividends, you may likely rouse suspicion from authorities.

2. Irregularities in accounting- A personal tax planning method should involve a clear-cut record of your financial statement. Any irregularity such as inadequate data or amount discrepancies may cost you your reputation.

3. Improper deductions on returns- Staggering as it may be, some people alter or even create fictitious details to chop off their taxes. For example, some employees overstate their travel expenses to get a cut, or, some claim to have contributed on a charity even if they haven’t. If you are claiming for some exemptions, you should have verifications to back your claims up. Otherwise, you may be alleged of fraud.

4. Improper allocation of income-There are instances when people allocate their revenues to those who belong to the lower tax bracket, like incorporators distributing income to their children. While this may seem OK, it’s not totally honest.

There are various ways to go about tax planning especially if you are a small business entrepreneur. Strategies can be applied to both your individual tax situation and the business itself, but the general goals would be: to reduce the amount of taxable income, to lower the tax rate, to claim any possible tax credits, and to control the time when a certain tax must be paid.

If you are totally clueless on how to perform personal tax planning the smart and legal way, you can spare yourself the agony by hiring a professional tax planner. He or she will be able to help not just by making you pay less but also by promoting better understanding of how the system works.

Income Tax Planning For Large Estates

If field goals were suddenly worth four points and touchdowns were worth five, football coaches would change their strategies. This type of scoring change has occurred in the estate planning field, but many people keep using their old playbooks.

Recent income and estate tax updates have adjusted how the planning game should be played. If your estate plan was drafted before they came into effect, reconsidering how you structure your estate could save you tens of thousands, or even millions, of dollars.

The Changing Rules

To understand these rule changes, we should rewind to the year 2000. The federal estate tax only applied to estates exceeding $675,000 and was charged at rates up to 55 percent. Long-term capital gains were taxed at 20 percent. Since then, the amount that can pass free of estate tax has drifted higher, to $5.43 million in 2015, and the top estate tax rate has dropped to 40 percent. On the other hand, the top ordinary income tax rate of 39.6 percent when coupled with the 3.8 percent Net Investment Income tax is now higher than the federal estate tax rate.

Although the top capital gains tax rate of 23.8 percent (when including the 3.8 percent Net Investment Income tax), remains less than the estate tax rate, these changes in tax rate differentials can significantly modify the best financial moves in planning an estate. While estate tax used to be the dangerous player to guard, now income taxes can be an equal or greater opponent.

Besides the tax rate changes, the biggest development that most people’s estate plans don’t address is a relatively new rule known as the portability election. Before the rule was enacted in 2011, if a spouse died without using his or her full exemption, the unused exemption was lost. This was a primary reason so many estate plans created a trust upon the first spouse’s death. Portability allows the unused portion of one spouse’s $5.43 million personal exemption to carry over to the survivor. A married couple now effectively has a joint exemption worth twice the individual exemption, which they can use in whatever way provides the best tax benefit. Portability is only available if an estate tax return is filed timely for the first spouse who dies.

From a federal tax standpoint, if a married couple expects the first spouse to die with less than $5.43 million of assets, relying on portability is a viable strategy for minimizing taxes and maximizing wealth going to the couple’s heirs. Estate planning for families with less than $10.86 million in assets is now much more about ensuring that property is distributed in accordance with the couple’s wishes and with the degree of control that they wish to maintain than it is about saving taxes. However, state estate taxes can complicate the picture because they may apply to smaller estates.

Below are a number of plays that families who will be subject to the estate tax should consider to optimize their taxes in today’s environment. Although many of the techniques are familiar, the way they are being used has changed.

The New Estate Planning Plays

Empowering Your Plan’s “Quarterback”

A successful quarterback has a solid group of coaches providing him with guidance, but is also allowed to think on his feet. Similarly, the quarterback of an estate, the executor or a trustee, needs to be given a framework in which to make his or her decisions but also flexibility regarding which play to run. Today’s estate planning documents should acknowledge that the rules or the individual’s situation may change between the time documents are signed and the death or other event that brings them into effect. Flexibility can be accomplished by expressly providing executors and trustees with the authority to make certain tax elections and the right to disclaim assets, which may allow the fiduciaries to settle the estate in a more tax-efficient manner. Empowering an executor has its risks, but building a solid support team of advisers will help ensure he or she takes the necessary steps to properly administer the estate.

Maximize the Value of Your Basis Adjustment

It’s a common misconception that lifetime gifts automatically reduce your estate tax liability. Since the two transfer tax systems are unified, lifetime gifts actually just reduce the amount that can pass tax-free at death. Lifetime gifts accomplish marginal wealth transfer only when a taxpayer makes a gift and that gift appreciates outside of the donor’s estate. In the past, people generally wanted to make gifts as early as possible, but that is no longer always the most effective strategy due to income tax benefits of bequeathing assets.

One big difference between lifetime giving and transfers upon death is the way in which capital gains are calculated when the recipient sells the assets. With gifts of appreciated assets, recipients are taxed on the difference between the transferor’s cost basis, typically the amount the donor paid for the asset, and the sales price. The cost basis of inherited assets is adjusted to the fair market value of the assets on the date of the owner’s death (or, in a few cases, six months later).

When choosing which assets to give to heirs, it is especially important to make lifetime gifts of assets with very low appreciation and to hold onto highly appreciated assets until death. If a beneficiary inherits an asset that had $100,000 of appreciation at the donor’s death, the basis adjustment can save $23,800 in federal income taxes compared to if the beneficiary had received the same property as a lifetime gift. Unfortunately, the basis adjustment upon death works both ways. If the bequeathed asset had lost $100,000 between the time it was purchased and the owner’s death, the recipient’s cost basis would be reduced to the current fair market value of the property. Therefore, it is advantageous to realize any capital losses before death if possible.

Holding onto appreciated assets until death is appealing for income tax purposes, but might not be advisable if the asset is a concentrated position or no longer fits with your overall portfolio objectives. For these types of assets, it’s worth analyzing whether the capital gains tax cost is worth incurring right away or if you should pursue another strategy, such as hedging, donating the asset to charity or contributing the property to an exchange fund.

Choosing not to fund a credit shelter trust upon the first spouse’s death is a perfect example of maximizing the value of the basis adjustment. These trusts were typically funded upon the first spouse’s death to ensure that none of the first spouse’s exemption went to waste. Since the portability rules allow the surviving spouse to use the deceased spouse’s unused exemption amount, it is no longer essential to fund a credit shelter trust. Instead, allowing all of the assets to pass to the surviving spouse directly allows you to capture a step-up in basis for assets upon the first spouse’s death, and then another after that of the second spouse. Depending on the amount of appreciation and the time between the two spouses’ deaths, the savings can be substantial.

Annual Gifting

Making annual gifts is a traditional strategy that remains attractive today. In addition to the $10.86 million that a couple can give away during their lifetime or at death, there are also some “freebie” situations where gifts don’t count towards this total. You can make gifts up to the annual exclusion amount, currently $14,000, to an unlimited number of individuals, and you can double this amount by electing to gift split on a gift tax return or by having your spouse make separate gifts to the same recipients.

Transferring $14,000 may not seem like a meaningful estate tax planning strategy for someone with more than $11 million, but the numbers can add up quickly. For example, if a married couple has three married adult children, each of whom has two children of their own, the couple could transfer $336,000 to these relatives each year using just their annual exemptions. If the recipients invest these funds, the future appreciation also accrues outside of the donors’ estates, and the income may be taxed at lower rates.

Contributing the annual exclusion gifts to 529 Plan education savings accounts for the six grandchildren can accelerate the gifting process and increase the income tax benefits. A special election allows you to front-load five years’ worth of annual exclusion gifts into a 529 Plan, which would currently allow $840,000 in total gifts to the six grandchildren. In this scenario, the grandparents would not be allowed to make any tax-free gifts to the grandchildren during the following four tax years. Since assets in a 529 Plan grow tax-deferred and withdrawals for qualified educational expenses are tax-free, you can realize substantial income tax savings here. If you assume the only growth in the accounts is 4 percent capital gains, which are realized each year, that results in about $8,000 in annual income federal tax savings per year, assuming the donor is in the top tax bracket.

You can also pay a student’s tuition directly to the college or university, since these payments are exempt from gift tax. This exception applies to medical expenses and health insurance premiums as well, as long as payments are made directly to the provider.

Given that annual exclusion gifts don’t impact the $5.43 million lifetime exemption, I recommend making these gifts early and often, but remember to give away cash or assets that have very little realized appreciation. The earlier you make a gift, the more time the assets have to appreciate and pay income to the recipient.

Lifetime Charitable Giving

Earlier I mentioned that you want to avoid giving away appreciated securities during your lifetime. The exception to that rule is a gift to charity. By donating appreciated securities that you have held for more than one year, you can get a charitable deduction for the market value of the security and also avoid paying the capital gains tax you would incur if you were to sell the asset.

If you know you have charitable intentions, it is more effective to donate appreciated securities earlier in life, rather than at death, since doing so removes future appreciation of the assets from your estate.

Using Trusts to Increase the Effectiveness of Transfers

Lifetime transfers to standard irrevocable trusts are no longer as appealing as they used to be, now that the estate tax rate is closer to the capital gains rate. Assets transferred to irrevocable trusts during the grantor’s lifetime typically do not receive a basis step-up upon the grantor’s death. Therefore, determining whether it is more appealing to make lifetime transfers or bequests in a specific circumstance requires making assumptions and analyzing probable outcomes.

Nonetheless, funding certain trusts in conjunction with other planning techniques can increase the planning’s effectiveness. An intentionally defective grantor trust (IDGT) is one of the most appealing types of trusts for wealth transfer purposes, because the donor is treated as owner of the trust assets for income tax purposes but not for estate and gift tax purposes. A defective grantor trust is a disregarded entity for tax purposes, so any income that the trust earns is taxable to the grantor. By paying the tax on trust income, the grantor effectively transfers additional wealth to the beneficiary.

Another popular strategy is for a grantor to make a low interest rate loan to a defective grantor trust. The trust then invests the funds. So long as the trust’s portfolio outperforms the interest rate charged on the loan, the excess growth is shifted to the trust with no transfer tax consequence.

One of the common ways to cause a trust to be intentionally defective is for the trust document to allow the grantor to retain the power to substitute assets held by the trust for other assets. Assuming a trust has this provision, it is very powerful to routinely swap highly appreciated assets held by the trust that would not be eligible for a basis step-up with assets of equal value held by the grantor that have little to no appreciation, such as cash.

Rather than funding a credit shelter trust upon the first spouse’s death, a surviving spouse might choose to receive all of the assets outright and then immediately fund an IDGT that includes the power to substitute assets. The trust’s income would be taxed to the surviving spouse, allowing for additional wealth transfer, and the grantor could use the swapping power to minimize the income tax cost of the lost basis adjustment.

Any transfer technique, such as a grantor retained annuity trust (GRAT), that allows a donor to transfer assets without generating a gift is also valuable, since it helps preserve the lifetime exemption amount as long as possible, thus maximizing the assets that can benefit from adjusted basis.

Finally, trusts can be useful for keeping assets out of your estate that never should have been included in it. For example, wealthy individuals should generally purchase life insurance through an irrevocable trust, rather than directly in the insured individual’s name. Life insurance owned by decedents is includible in their taxable estates. By creating a trust funded through annual exclusion gifts and having the trust purchase the policy, you can ensure that the estate tax does not take 40 percent of the policy’s proceeds.

Avoid Paying Estate Tax on Income Tax

While the term “income in respect of a decedent” (IRD) might be obscure, it’s important to understand it, since it’s one of the worst deals in town. IRD is income that a decedent was entitled to but did not receive prior to death. While unpaid salary and accrued interest are common examples, the biggest risks lie with retirement accounts and annuities.

Retirement accounts, such as 401(k)s and traditional IRAs, are typically funded with pretax money and taxed on the decedent’s estate tax return at their market value on the decedent’s date of death. However, because these are pretax assets, the beneficiary ultimately has to pay tax on the income before receiving it. In a simple example, if a decedent has a $1 million IRA that is being taxed on the estate tax return at 40 percent in 2014, the recipient would also need to pay additional tax on withdrawals from the IRA when he receives it. Assuming no growth in the assets and that the beneficiary is in the top income tax bracket, taxed at a rate of 39.6 percent, the recipient would need to pay $396,000 income tax as a result of the bequest and the estate would pay $400,000 of estate tax. This results in a total tax of $796,000 from the $1 million of assets. Compare this with a taxable account, in which assets would have their cost basis adjusted to the fair market value on the date of death, so the recipient typically needn’t pay much, if any, income tax to access the assets. Therefore, the tax would only be $400,000 – about half of the amount applied to the IRA.

The additional tax is a bit overstated in the example above, because the estate tax paid on the IRD can be an itemized deduction that is not subject to the 2 percent floor. Nonetheless, it illustrates the point that it is better to minimize IRD and the resulting double taxation if possible.

It may make sense to take distributions from your own pretax accounts in certain situations, because paying the income tax during your life allows you to reduce your ultimate estate tax exposure. Converting traditional retirement accounts to Roth accounts can also help maximize the value of your estate. Most people will want to avoid annuities too, not only because of their typically high fees, but because they are treated as IRD and do not receive a basis adjustment upon the owner’s death.

The right play for your estate plan has become even more specific to your situation: where you live, how you invest, your life expectancy, your goals and priorities, and your future life plans. With no one-size-fits-all answer, it’s important to run financial projections to understand both the income and transfer tax consequences of your choices, so you can determine the best moves for your situation. Make sure you have someone on your team that can accurately analyze what’s best for your situation and, above all, keep your game plan flexible.

IIT (Individual Income Tax) Planning for Expatriates in China

‘What is the law regarding the taxation on income of expats in China?’ ‘How is IIT of expats declared in Shanghai?’

‘How to calculate my IIT to avoid repeated levy by my own country?’

-These questions are usually asked by my clients,and Legal tax avoidance is a forever hot topic.

China’s individual income tax [IIT] rate, from 5% to 45%, is in the upper level of the world. Due to the high costs and complex rules, you do have the demand and opportunity to save your individual income tax in a legal and proper way. An anticipatory and skillful tax plan can help!

-Am I liable to pay individual income tax?

Identification determines your tax liabilities. It is not always high earners who pay the highest marginal rates of taxes on income. There are different tax rules, rates, and exemptions for different people. Even for persons who stay in China with same purpose, that is, with same kind of visa, different tax treatment may occur due to different certificates they hold.

Example of Practice: a man was recruited by a Chinese University as an English Teacher, this person can get Expert License (Culture & Education), with which he apply for the working visa and resident permit. Compared with those who hired by company, like WFOE, JV, or RO, even they have the same purpose to WORK here with the same kind of “Z” visa, the second person cannot be treated tax free for his oversea income due to the lack of ‘Expert License’.

-Can I save tax by controlling the days spent in China?

Good controls of resident days help avoid huge tax burden. Under China Tax Treaty, different exemptions apply to different accumulative days of presence in the PRC in a calendar year. Less than 90/183 physical days, over 90/183 days but not exceed one year, and even one year to five, can enjoy tax benefits respectively.

Technical tips: Avoid being taxed on worldwide income by breaking the 5 year chain. Leaving China for 31 days consecutively or 91 days cumulatively by the 5th year will help. Furthermore, leaving China for 31 days consecutively or 91 days cumulatively in the 6th year help you restart the 5 year clock.

-Which kinds of income are taxable?

Rearrange the nature of your income to make full use of the exempted categories. Temporarily exempted expenses include the house allowances, meal allowances, removal compensation, laundry allowance obtained for foreigners in non-cash form or in reimbursement, the relative visit allowance, language training allowance, children education allowance and the dividends and bonus obtained from FIEs.

Technical tips: Never getting cash income to pay your personal living expenses. Reimbursements upon actual figures help you to maximize the exempted expenses. Pay living expenses after the receipt of cash income bring loss to you compared with submitting the actual invoices to employer and get the net amount.

-International Tax Planning with Tax Protection & Equalization Policies.

Due to the worldwide different tax rates, in order to ensure that the expatriate assignment is “tax neutral”, many companies pay taxes that exceed the expatriate’s hypothetical tax liability. Companies also implement tax equalization policies so that expatriate employees are treated fairly and consistently throughout the world.

Example of Practice: an UK expatriate in China is treated the same as work in his home town and in US although the tax laws in these countries are vastly different. After the deduction of his oversea hypo tax, the person enjoys the less tax benefits, or the employer affords the extra cost during his stay in China

What Is Income Tax Planning?

There are many things in life we try to plan for. We try to plan home and car purchases, the future of our children, and our retirement. Not many people plan their income taxes because they do not know anything about it. What is income tax planning? Why is it important?

The most important part of tax planning is to minimize your taxes. Income tax planning involves determining which tax laws apply to you. Every person has a different income situation that will fall under certain laws. To make sure you are reducing your tax liability, you need to create a tax plan, which can be done in three different ways.

The first way of creating income tax plans is through your adjusted gross income. The AGI is the result of subtracting and adding certain aspects to your income. Things like investments are added to your wages, while things like mortgage payments subtract from your wages. Higher AGI totals mean a greater tax liability. If you want to reduce your tax liability through your adjusted gross income, start a retirement plan like a 410k. When you add money to this plan, your income is reduced, which in turn lowers your tax liability.

A second way to reduce your taxes through a tax plan is through deductions. Most people assume that tax deductions are only for business owners. Itemizing your deductions is helpful. Many people can deduct things like health care expenses, car registration fees, the interest on your mortgage, and charitable gifts.

Tax credits are a third aid in your income tax planning. There are many different kinds of tax credits, and you won’t be eligible for all of them. Even a few, however, can help reduce the tax amount you would owe. There are college tax credits, credits for certain home renovations, and for adopting children. Most common is the earned income credit. Utilizing the credits that are available to you can help reduce how much taxes you will owe.

You can also reduce the amount of taxes you would owe by raising the withholding amount from your wages. Many people with dependents think it is better to claim zero dependents on W-2 forms because they get more of their paychecks. Actually, by increasing the amount that is taken out of your pay, you get a bigger refund on your income tax.

It is important to always keep receipts. You never know what can be claimed as a deduction. Purchases for home improvements, gas expenses, and anything related to your job could qualify. If your itemized deductions are greater than the standard deduction, you can choose them but you can use both types of deductions.

When people hear the question what is income tax planning, they often think it is just about filing your taxes properly, but it is more than that. It is about what you do before it is income tax time, throughout the remainder of the year. It is about making sure that you have everything set up so that you are making sure that you are doing everything that you can to lower how much taxes you will be responsible for.