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Importance of Tax Planning
Tax planning helps an individual or a business in delaying/avoiding the payment of their taxes(through availing allowances, exclusions, exemptions, and deductions mentioned under the Income Tax Act 1961.) Tax planning can be seen as a part of financial management, as financial management enables one in fulfilling their monetary goals(short term or long term), and since tax is itself a big financial burden on people/businesses, efficiently approaching taxes; can help in decreasing tax liabilities and also in securing one’s future and post-retirement life.
If you’re undergoing a major life event like job switching, marriage, pregnancy, sending your children off to college, retirement, and more, planning your taxes can act as a cushion to protect you from needless strain during these times. Tax plans can be of various types:
- Short-term tax plans: To reduce taxes at the end of a particular year
- Long-term tax plans: Plan at the beginning/end of a year
- Permissive tax plans: To avail various permission provisions under the law that help save taxes
- Purposive tax plans: Provides a chance to make different investments
Difference between Tax Evasion and Tax Avoidance
The primary difference between the two terms is that tax evasion is per se illegal (it involves practices like intentional hiding or misrepresentation of one’s true income, manipulation of the books of accounts, not filing income tax returns, etc.), while tax avoidance is a legal approach to tax-saving (by availing tax deductions, parking money in several legal entities to be able to enjoy tax slab benefits, and using similar loopholes under the law.)
Some Techniques/Options That Can Help You Save Taxes
Choosing Tax-Efficient Investment Options
A few of these are mentioned below:
- PUBLIC PROVIDENT FUND(PPF): There exists an annual cap of Rs.1.5 lakhs for investment under this scheme that is counted not based on the account(s) but on the basis of earning member(s). Also, you need to invest money in PPFs for at least 15 years(though there is an option of partial withdrawal after 5 years.)
- UNIT LINKED INSURANCE PLAN(ULIP): Offers multiple fund options(both risk-heavy and risk-light), and the investor can also switch between funds(go from a highly risky option to a safer option.)
- GUARANTEED SAVINGS PLAN: Kind of similar to ULIPs, except that they do not offer multiple fund options. The maturity value here is tax-exempt if the annual premium is less than 10% of the total policy sum. Premium up to Rs. 1.5 lakhs reduces tax liability under section 80C of the Income Tax Act(which allows certain expenditures and investments to be exempt from tax.)
- NATIONAL PENSION SCHEME: As per the Income-tax Act, this scheme provides the following advantages:
- For individual contributors: Claim for tax up to ₹1.5 lakh under Section 80CCE.
- Additional deduction of up to Rs. 50,000 is allowed under Section 80CCD (1B).
- Corporate contributions(by employer), up to 10% of basic salary- tax exempted, under Section 80CCD (2)
- Other tax-saving investment options include a National savings certificate, Tax-saving fixed deposits, an Equity-linked savings scheme, etc.
Deduction from the gross salary to bring down the total taxable income and consequently the total tax liability. Maximum limit allowed at present: Rs. 50,000
Section 80 G of the Income Tax Act aims to provide tax donations to charitable individuals. The benefactors need to ensure that they contribute only to specific funds & institutions(those which are mentioned under this act.) Some donations do allow up to 100% deductions, while the rest have limits attached to them. Donations made to foreign entities are not covered under this section, and no tax deductions can be claimed over them.
Long-Term Capital Gains
Long-term capital gains refer to profits made on selling long-term capital assets(like property, plants, buildings, machinery, etc.) When a property is purchased and then sold for a profit, Long Term capital gains tax has to be paid on it. To boost property investment prospects, the government of India has provided several ways to alleviate the tax burden of individuals.
Sale of the Property: Section 54F provides that if you use your capital gains to purchase a new property(either 1 year before or 2 years after selling the old property) or construct new property(within 3 years of selling the present property), you can be exempted from paying taxes on this.
They are reinvesting in Bonds:Like the Rural Electrification Corporation Limited (RECL) and the National Highways Authority of India (NHAI) capital bonds.
Capital Gain Account Scheme: By putting your capital gains in this scheme, you do not need to pay LTCG tax, and you can keep your gains safe without buying a property with it.
Availing Of A Home Loan(Sec 80 C)
To make home purchases more lucrative for the consumers, the government of India provides tax deductions on principal + interest paid on home loans. The relevant sections from the Income-tax act are:
Section 80C: Repayment of the principal amount as a deduction. Maximum limit = Rs. 1,50,000
- Section 24: Repayment of interest amount as a deduction.
- Section 80EE: Annual deduction of Rs.50,000 on interest(FOR FIRST TIME HOME BUYERS.) The value of the property should be below Rs. 50 lakhs and the value of the loan should be below Rs. 35 lakhs.
- Section 80EEA: Annual deduction of Rs. 1,50,000 on home loans(FOR FIRST TIME HOME BUYERS.) The value of the house should be Rs. 45 lakhs or below.
Life Insurance Policy
Section 80C of the Income-Tax Act, 1961 provides benefits for life insurance. The government has allowed a maximum of ₹ 150,000 as a deduction to individual taxpayers under this section (ANNUALLY.) This deduction is given against the insured’s premium for the policy. 3 relevant sections here are:
- SECTION 80C: Exemptions allowed for under this section is up to Rs. 1.5 lakhs/year. The tax benefit is available on premiums paid towards policies of self, the spouse, and dependent children. Only 10% of the sum assured can be used for tax exemption, and if the premium exceeds 10% of its sum assured, the excess amount cannot be used for tax exemption.
- SECTION 10(10D): Pertaining to the taxability of claims. Suppose you have purchased a life insurance policy and appointed one of your family members as its beneficiary, in the event of their passing away. In that case, this death benefit will get disbursed, and it is not meant to be treated as an income(i.e. it is not eligible to be taxed.) This section requires the premium to be < 10% of the assured sum for insurance plans purchased after 01-04-2012.
- SECTION 80: Pertaining to Medical insurance/health insurance. Premiums paid on health insurance policies can be claimed as exemptions.
- Tax benefits for the self, spouse, and dependent children: Rs. 25,000
- Additional benefits over parents’ insurance: If they are below the age of 50, then Rs. 25,000 and if above 60, then Rs. 50,000.
Exemptions On Living On Rented Premises
House rent allowance is provided to employees who live on rented premises and not in houses they own. From the financial year 2020-21, it has been left up to the taxpayer to decide if she wants to opt for the older tax regime(along with deductions and exemptions) or the newer one(without tax deductions and exemptions.) Under section 80 GG of the Income-tax act, both self-employed people and salaried people(who do not receive any HRA) can claim HRA exemptions. In case the rent is paid > 1 Lakh, the individual can claim HRA exemptions towards it. The amount of HRA exemption is deductible from the total income before arriving at a gross taxable income. The tax exemption for HRA is the minimum of:
- Actual HRA received
- 50% of salary if living in metro cities, or 40% for non-metro cities; and
- Excess of rent paid annually over 10% of annual salary
Donations Towards Political Parties
Section 80 GGC of the Income Tax Act deals with voluntary contributions made by individuals to political parties. The doner can contribute 10% of their gross earnings, the contribution cannot be made in cash, and the total amount of deduction cannot be more than the individual’s total taxable income (the individual can get up to 100% deduction upon their contribution.) Section 80GGB, on the other hand, deals with companies’ contributions towards political parties, and here also, up to 100% deduction can be claimed on the contribution. The Income Tax Act does not put a cap on the amount that can be contributed to political parties, but the Companies Act of 2013 does restrict this percentage to 7.5% of the businesses’ net profits.
Loans For Higher Education
Section 80E of the Income-tax act covers the deduction of interest for investment in higher education. The loan must have been obtained from a financial institution or charitable institution.
Payment Of Tuition Fees Of Children
If the fee is below Rs. 1,50,000, then you are eligible to be exempted from paying tax on this money.
Every sound adult must understand about the basics of finances and taxes. This can save us from being stripped of our hard-earned money through completely legal routes and also help us better manage our finances, life events, and the future.
This article is authored by Anshika Singh, student at Institute of Law Nirma University.
Why do I need to plan my taxes?
You can manage your finances well and do not have to panic when the filing date is on your doorstep.
Can’t I just consult a Chartered accountant for this instead?
Of course, you can. You’re welcome to. But knowing the basics about your very own money, something that you have to deal with for the rest of your life, never hurts, right?
Wait, isn’t tax-saving illegal in the first place?
No, that’s illegal tax evasion—something you do by hiding your true income or manipulating your account books. If you avail of exemptions/deductions mentioned under the law, you’re doing nothing illegal. In fact, you’re only helping yourself in the process and treating your finances with respect.