Tax Research Paper: Maxims Of Tax Planning And Six Steps Of Tax Research

I. Introduction

Business organizations use financial planning techniques to help make decisions that will maximize the net present value of the entity. An important component of the financial planning process is tax planning, which is the structuring of transactions with the intent reducing tax costs and gaining tax benefits. Strategic tax planning is a common occurrence in the business world because of its ability to help companies maximize their after-tax value.

Typically, firms use the services of outside specialists, also known as tax researchers, in tax planning. The role of the tax specialist is to determine the optimal business decisions that its client firm should make, as they relate to tax. When the tax consequences for a firm differ among decision alternatives, tax specialists help to identify the most optimal course of action for management to make in order to maximize their after-tax income.

Assuming the income potentials of all possible decisions are equal, a firm will focus on minimizing their overall tax expense. In order to exploit the differences in tax treatment among alternative transactions, a tax specialist must give careful consideration to the structure of the entity, the timing of the tax payments, the government bodies that have the jurisdiction to tax the transactions, and the categorization of the income or expense generate as a result of the nature of the transaction. These four variables are considered to be the most important guidelines used by companies when developing tax strategies.

II. The Four Maxims of Tax Planning

The first the major tax planning maxims, entity variable planning, says that a company should use its structure to its advantage. What this means is that when there are two related parties under common control and one is subject to a lower tax rate than the other, more income should be allocated to that entity, thus allowing for a reduction in the overall income tax expense incurred by the firm.

The second planning maxim deals with the time period variable of a transaction. Due to the time value of money, meaning that a dollar today is worth more than tomorrow, it is beneficial for a company to defer tax liabilities as long as possible. This delay will afford the firm other opportunities for investment that they would not otherwise have. Another way to use to planning to alter the timing of payments in a way beneficial to the company is by accelerating the tax deductions received by the firm. This means that tax deductions will be greatest for the company, due to the fact that they are valued higher in the present than in the future. In either case, whether pursing a tax strategy that defers liabilities or one that accelerates deductions, the impact on the company's income is greatest realized when the cash flows from income are separated from the cash flows related to taxes. However when separating the two cash flows is not possible, there are several ways an organization can structure its transactions that will enable it to take advantage of tax laws that provide for the most favorable tax treatments.

Jurisdiction variable planning represents the third major guideline followed in effective tax planning. In this case, the objective is to minimize tax expenses by structuring transactions differently depending on how many government bodies have the jurisdictions to levy taxes on the company, based on its location. Also, a tax planner must consider the tax rate imposed by government bodies that hold levying authority over the company of interest. Jurisdiction variable planning will cause firms to make decisions that impact where they locate various parts of their operation and how they chose to structure the company.

Finally, the fourth and final maxim of tax planning has to do with tax character. This means that the tax expense incurred on a transaction often is related to the type of income generated by the transaction. Extraordinary income, for instance, such as capital gains, is often taxed at a higher rate than ordinary income, like that earned from continuing operations. A second example of where the tax character may cause tax consequences to differ among similar transactions is in the fixed income market. When a company buys a treasury bond from the federal government, it is subject to both federal and state/local taxes, while a municipal bond is exempt from all federal taxes, an is only taxed at the state/local level. In this case, while the NPV of the federal bond may be greater before taxes, it is often the case that the after-tax NPC of the municipal bond is greater when considering the two investments on an after-tax basis.

III. Tax Research

In order to effectively structure transactions that will receive the best possible tax treatment under US law, meaning the lowest costs and greatest benefits, a process known as tax research must first be performed. Because, legally, a company cannot re-write its history, meaning it cannot change previous actions for purposes of obtaining a tax benefits, a tax specialist will spend the majority of their time deal with open-fact transactions, which are proposed future transactions, and in turn spends little time researching closed-fact transactions, those which took place in the past. By conducting an adequate amount of research a tax specialist is able to determine the probable tax consequences of all alternative transactions that are being considered by its client firm. They are then able to identify the specific courses of action that will enable the firm to maximize their cash inflows while minimizing their cash flows, as they related to taxes. Typically this research process is divided into six distinct steps.

IV. The Six Steps of Tax Research

To begin it is important that the tax consultant is able to fully understand the proposed transactions as well as the surrounding facts that can potentially impact the cash flows of the transaction and its legality. Specifically the specialist aims to understand the client's main objective as well as the expected results of the transaction, which will allow him/her to create a tax plan that best meets its client's needs.

The second step in tax research is to identify the tax issues, problems, and opportunities that are revealed by the facts and information gathered in the prior step. This enables the tax consultant to devise specific tax research questions that must be addressed in order to create the most beneficial tax plan for the company. In most cases, it is found that there are several questions that must be answered in order to establish the ideal tax strategy. In this case,