Albert Einstein is credited with saying, “There are only two things that are certain in the universe – death and taxes.” Whether or not Einstein indeed said those words is debatable, but the message carries with it a kernel of truth that is both funny and frightful. Even more amusing is the notion that for some people, taxes can be more frightening than death.
While people can be quite fortunate to miraculously cheat death in very rare occasions, “cheating” on taxes is expectedly and thankfully a more regular occurrence. In fact, most tax laws of governments are worded in such a way that some tax relief can be availed readily by their citizens. For the common folk, “tax break” is the term they are more familiar with than tax relief.
Tax Reduction versus Tax Evasion
Tax breaks are the legal ways of reducing ones taxes. Throughout history, taxation has been somewhat of a necessary evil. Governments need it to function properly, but their citizens do not exactly welcome it with open arms, especially in times of financial difficulties.
Tax avoidance is a recognized natural reaction to taxation. As such, a country’s legislators are often juggling tax laws sometimes increasing taxes for economic adjustments and sometimes amending them to provide some level of relief. Such legislated forms of tax relief are the acceptable tax breaks that allow people some elbow room to pool the amounts they are able to save back into their budgets or into their investments.
In contrast, tax evasion involves using illegal methods to reduce or avoid paying taxes altogether. Evading taxes is a criminal offense in practically all countries, punishable either by a substantial fine or imprisonment, and, in many instances, by both. Often, misrepresentation of income or falsification of financial records is involved in tax evasion cases. Outright non-declaration of taxable income is also a form of tax evasion.
It is therefore important in financial management to have legal advice within reach to ensure that measures to be taken either by individuals or corporations for reducing tax liabilities are well within legal parameters.
Different Kinds of Tax Breaks
As there are different kinds of taxes, there are also different ways to legally avoid them. Generally speaking, tax breaks can be divided into three distinct forms. These are tax exemptions, tax credits and tax deductions.
Tax exemptions: Nearly all governments normally allow some exemptions for almost all the category of taxes they impose (e.g. income tax, property tax, etc.). These exemptions are targeted mostly to specific segments of the population or to beneficial interest groups.
For example, in most countries there are exemption levels for personal income tax depending on the age of the taxpayer or their civil status. Also, most charitable organizations are given tax exempt status. In some states, war veterans are provided tax exemptions as well.
Tax credits: While tax exemptions are a common form of relief found among nations with modern taxation systems, tax credits may not be as universal. Tax credits may be considered payment in part of total taxes due, as in the case of a withholding tax. Tax credits may also be in the form of a benefit, either refundable or not, awarded to a citizen under specific legislation such as a child tax credit.
Tax deductions: Mostly applicable on income tax, tax deductions are another common form of tax breaks. The tax system allows for certain expenditures to be deducted from one’s gross taxable income. There are standard deductions and there are itemized deductions and usually, people are given a choice of one or the other. In some cases, applying a standard deduction would be better; in other cases itemized deductions can result in lower taxes.
These categories of tax relief may or may not exist in particular jurisdictions and so may not always be available for citizens. Similarly, implementation of such tax reduction options will undoubtedly vary from one tax regime to the next.
Maximizing Tax Breaks
Taxpayers should avail themselves of applicable tax breaks as much as possible to maximize their tax savings. However, most people are not as knowledgeable about their country’s tax laws as they should be. As a result, many tax relief opportunities are not utilized and the taxpayer ends up paying more tax than what the law allows.
Engaging the services of a qualified accountant, financial adviser or a tax lawyer can help in reducing ones tax liability. Certain exemptions, deductions or tax credits which were previously not applied simply because the taxpayer didn’t know about them, may amount to substantial tax savings. For example, some countries have enacted tax legislation favoring taxpayers who purchased environmentally friendly vehicles (e.g. hybrid electric cars).
Other financial strategies, for instance using legal tax shields or tax shelters, certain annuity investments, or setting up offshore accounts, are additional areas that these financial experts can help with to improve one’s finances. Because such professionals are well versed in matters of taxation and finance, they are able to place legal tax breaks as well as other financial strategies into an entity’s overall financial plan. The net effect for the taxpayer is optimized savings and extra funds for other beneficial purposes.