Introduction to Personal Income Tax Planning 

    Published December 10, 2004

    Definition of Income Tax Planning

    Income tax planning may be defined as the development and implementation of appropriate strategies to reduce, affect the timing of, or shift either current or future income tax liabilities. Recommended strategies are based not only on the tax consequences themselves, but also in light of the individual's overall financial goals.

    Income Tax Planning in the Context of Personal Financial Planning

    In the context of personal financial planning ( PFP), income tax planning is driven by your client's overall financial planning goals, and is not an end in itself. While you may often perform consultations or engagements that are entirely tax oriented, tax planning as part of a PFP engagement assumes integration with other PFP areas. For example, an income tax projection is necessary to determine cash flow available to fund goals.

    Income Tax Planning Goals & Strategies

    Income tax planning has two primary objectives:

    • Minimizing overall income tax liability

    • Fulfilling overall financial planning goals with minimal tax consequences


    These objectives are addressed through three broad strategies:

    1. Reducing the income tax consequences of a transaction or arrangement

    2. Shifting the timing of a taxable event

    3. Shifting income to another taxpayer

    Reducing Tax Liability

    Tax reduction strategies are those that produce tax-free income, recharacterize nondeductible expenditures as deductible expenditures, or result in income being taxed at a lower tax rate.

    Examples include:  

    • Shifting investments from corporate bonds to municipal bonds
    • Establishing a home equity loan to generate deductible interest expense

    Timing Taxable Events

    Strategies for the timing of income tax liabilities involve tax deferral or acceleration, by shifting the timing of either income or deductions. Examples include:

    • Contributing to 401(k) plans and IRAs
    • Selling appreciated assets to maximize capital gains treatment
    • Grouping income tax payments, charitable contributions, and other deductions
    • Converting income investments to growth investments

    Shifting Income

    Income shifting strategies focus on transferring income from one individual or entity to another in a lower tax bracket, reducing the overall tax paid on the income. One hurdle clients face in these strategies is the loss of control over the income producing asset.

    Other Considerations

    Other considerations in developing tax planning strategies include:

    • Use of assumptions. You must determine the appropriate rates to be used for projections of short and long term income tax projections.
    • Audit risk. Income tax planning strategies carry some risk of audit by the IRS and state tax department.  
    • Cost benefit. Tax planning strategies should be evaluated in light of their costs, including fees, implementation costs, and the time and effort required by the client.
    • Changes in tax laws. In addition to monitoring changes in the client's situation, your strategies will be impacted by subsequent changes in federal and state tax laws.

    Tax Compliance

    Income tax compliance is not a de facto part of your income tax planning services. Since some clients may not distinguish between planning and compliance, it is important that you clearly manage client expectations, preferably in an engagement letter, whether your services include tax compliance services.

    Statements on Standards for Tax Services

    In addition to the general professional standards and the Statements on Responsibilities in Personal Financial Planning Services, when providing income tax planning or compliance services, you should be familiar and in compliance with the provisions of the AICPA's Statements on Standards for Tax Services. These statements address, among other issues, tax positions and the communication of tax advice to clients.





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