Is Tax Planning Risk Mitigation?

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I’m not entirely comfortable with lumping “tax planning” in with risk mitigation strategies for two reasons.  First, pure risk is random whereas taxes have a clearly defined timetable.  Second, poorly conceived and marketed tax marketing literature is a sign the plan runs afoul of anti-avoidance law, five judicial doctrines that allow courts to undo a transaction’s benefits if its substance differs from its form.  For now, suffice it to say that poorly marketed tax reduction ideas place the seller into the tax scammers group.

This does not mean that tax planning is not allowed.  In fact, a very strong argument could be made that an executive who didn’t consider the tax implications of a company’s business activities violated his fiduciary duty.  So – where is the line between proper planning and tax evasion?

I’ll answer that question in two parts. The first is to categorize the specific actions that are endemic to planning.  The second is to provide a brief explanation of specific anti-avoidance law doctrines that create the legal boundaries between proper and improper planning.

Let’s begin with the specific things that are possible under the tax code.  There are contained in the code.  There are three “gross”[1] numbers that are key to tax planning:

Gross income is “All income from whatever source derived.”[2]

Adjusted gross income gross income less specifically enumerated deductions.[3] 

Taxable income is “gross income minus the deductions allowed by [the tax code].”[4]     

The above numbers can be thought of as simple mathematical totals.

The code specifically defines and allows three actions related to the above numbers.

Deductions: these are specifically enumerated in the code[5] and are subtracted from gross income.[6] 

Exemptions: these items are clear “accessions to wealth” but are excluded from computing gross income, usually for public policy reasons.

Credits: there are a dollar for dollar reduction in tax.[7]  They are therefore preferred.   

There are four additional strategies that require transactional planning:

Deferral: moving a taxable event to a future tax year.

Conversion: changing the amount of tax from a higher to lower amount (usually this means changing ordinary income into capital gain).

Extraction: moving a taxable event from the tax base (this usually involved moving money offshore).

Compression: lowering the total value of an asset.  
 
In other words, despite all the bells and whistles of tax planning sales literature, there are only seven tools in the planner's tool belt.

Next, I'll take a look at some specific techniques used by planners.

[1] Here, the noun gross is used as a noun and means “overall, total” or “aggregate.”  (https://www.merriam-webster.com/dictionary/gross)

[2] 26 U.S.C. §61

[3] See generally §62

[4] §63(a)

[5] See generally §151-§250

[6] 26 USC §161

[7] See generally §21-§54AA