Tax Efficiency Definition
Tax efficiency, defined as the process of organizing an investment so that it receives the least possible taxation, is as important in general investment as it is in business. Business, commercial investments, and even private investment vehicles can experience tax efficiency through planning. Any time a person has caused a change which avoids a higher tax rate they are experiencing the benefits of a change in their tax efficiency rating.
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Tax Efficiency Meaning
Tax efficiency means paying less to the government due to some changes in the structure of an investment. This can have relatively minor or an extremely profound effect on net profit depending on the scale of the investment in question.
For public market investments, achieve an increased tax efficiency ratio through a variety of means. Tax free bonds and money market accounts, stocks which are held over one year, and tax efficiency of etfs other than this can be utilized for an income which is greater than their taxed counterpart.
For businesses, tax efficiency can be gained through other means. The structure of the legal entity that is the business can effect tax efficiency: LLC’s do not experience double-taxation like corporations do. Additionally, moving finances from account to account inside the business can also leave less to be taxed. Reinvesting profits into research and development rather than taking company profits is one option: the business experiences less capital gains than if it kept the income.
In personal finances, other investment tools can increase tax efficiency. For example, a Roth IRA has increased tax efficiency over some other tools. For proper planning it is important to consult with a financial planner and find out which tool is best for each circumstance.
Tax accountants are the experts in creating tax efficiency. For those who have a large amount of funds tied up in investments a tax accountant is a necessity. These trained professionals can inform the business owner on the proper structuring of business, investment, and personal finances.
Dom is a business owner who is experiencing new success. His business is taking off like never before and has provided a lot of extra income as it does this. Dom has no need to reinvest this money into the business as it already has enough free cash flow. Dom has decided to diversify his holdings by investing in other places. He now needs to bring it together to increase his tax efficiency of index funds and business dealings alike.
Dom arranges a meeting with both his financial advisor and his tax accountant. He knows these two will not see eye-to-eye on everything but wants to bring his investments to work together.
His meeting goes quite well. Dom has received advice that will benefit him immensely. From his tax accountant, he received advice on restructuring his business entity as well as accounting methods. From his financial advisor, he was informed about places to invest which hold value steady and will increase tax efficiency of mutual funds. Dom leaves with a good attitude that tomorrow will be better than today.
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