Tax planning
What the exam tests
Domain 7 tests marginal versus average tax rates, deductions versus credits, deferral, capital gains and the timing of income and deductions. It is applied arithmetic and planning logic, not a tax-law memory test; local rules vary, so identify the principle and state the assumption.
Core rules
- The marginal rate applies to the next unit of income; the average rate is total tax ÷ total income. Planning decisions use marginal rates.
- A deduction reduces taxable income; a credit reduces tax directly. A 10,000 deduction at a 30% marginal rate saves 3,000; a 3,000 credit saves 3,000.
- Deferral is valuable because tax on growth is postponed; tax-free compounding beats taxable compounding over long horizons.
- Match income and deductions in the same period; accelerate deductions and defer income only within legal limits.
- Capital gains treatment, loss offsets and holding periods are jurisdiction-specific; confirm before recommending.
- Tax avoidance is legal structuring; evasion is illegal. Never advise concealment.
Worked example
A client in the 30% marginal band can contribute 10,000 to a deductible retirement account. The immediate tax saving is 10,000 × 30% = 3,000, so the net cash cost is 7,000. If the 10,000 grows at 6% for 20 years, it becomes 10,000 × 3.207 = 32,070 before withdrawal tax. The same 7,000 in a taxable account grows to 7,000 × 3.207 = 22,449 before tax on dividends and gains. The comparison must include the tax rate at withdrawal and the tax drag on the taxable account; deferral usually wins when the withdrawal rate is equal or lower.
Traps
Confusing marginal and average rates; ignoring phase-outs and thresholds; assuming deductions are worth their face value; forgetting tax on withdrawals; applying one country's rules to another.