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Tax planning should be an integral part of your finances. It’s your loss if you don’t make use of the available deductions and exemptions to save on taxes. Paying taxes is a way of contributing to the nation’s development, but when the government is providing you with options to save taxes, it is only wise to do so.
Let’s understand tax planning and its benefits with the help of an example. Consider Akash, an IT professional living in a metro city with annual compensation of Rs 16 lakh. He is currently repaying an education loan of Rs 22 lakh which he had availed to fund his higher education. His monthly salary is Rs 1,33,334.
The break-up of his salary is as follows:
Basic salary: Rs 50,000
House rent allowance: Rs 25,000
Special allowances: Rs 58,334
As per the information above, Akash is falling under the 30% income tax bracket, the highest of the current income tax slabs. If Akash doesn’t have a proper tax-planning in place, then he will end up paying a substantial amount as taxes every year.
The tax payable by individuals earning over Rs 10 lakh a year is a whopping Rs 1,12,500 plus 30% of the income over Rs 10 lakh. Akash did not make any other investments apart from the compulsory EPF contribution of Rs 21,600 last year. As a result, he could save only Rs 6,740 in taxes last year.
The Income Tax Act, 1961, provides taxpayers with several options to reduce their tax payable. Various sections offer tax deductions, out of which Section 80C is the most popular. Amongst exemption, claiming house rent allowance (HRA) is the widely used exemption. The best way to save taxes is to lay out a financial plan as and when there is a revision in your salary and to stick to it. Also, it is essential that you make tax-saving investments in the first half of the financial year, so that you don’t make hasty investment decisions at the end of the year. Furthermore, it would help if you claimed all the exemptions and deductions you are eligible for. To do this, you should know and understand the various exemptions and deductions available.
Section 80C is the most popular section in the Income Tax Act, 1961. It provides provisions for taxpayers to save up to Rs 46,800 a year in taxes. Section 80C covers several tax-saving investment options, and investors can choose to invest in any of the options under Section 80C to avail the deduction of up to Rs 46,800 a year. The best tax-saving option under Section 80C is equity-linked savings scheme (ELSS). It is an equity-oriented mutual fund scheme, offering the dual benefit of tax-saving and wealth growth.
Apart from ELSS, you can invest in government savings schemes such as Public Provident Fund (PPF), National Savings Certificate (NSC), tax-saving FDs, and so on. Cumulative investments in these options will provide deductions of up to Rs 1.5 lakh. You can also claim deductions towards your payments made towards children’s school tuition fee and home loan principal repayment under Section 80C.
Now, let’s see how Akash can save more tax under Section 80C. Akash is already making a compulsory EPF contribution of Rs 21,600. That means, he still has a provision to claim a deduction of Rs 1,28,400 by making investments under options covered under Section 80C. Considering that he fully utilises the Section 80C limit, his tax savings for the year would be:
|Particulars||Income tax saved when 80C limit is not fully utilised||When 80C limit is fully utilised|
|Total deduction under Section 80C||Rs 1,50,000||Rs 1,50,000|
|Compulsory EPF contribution||Rs 21,600||Rs 21,600|
|Investments in Other Section 80C Options (ELSS, PPF, LIC Policies, and so on)||Nil||Rs 1,28,400|
|Income tax saved||Rs 6,740||Rs 46,800|
|Additional taxes saved after fully utilising Section 80C limit||Rs 40,060|
Taxpayers staying in rented accommodation can avail exemption on the rent paid by them under HRA exemption. For this, they need to furnish the rent receipts issued by their landlord. The amount of exemption will be the least of the following: i) Total HRA received. ii) Total rent paid reduced by 10% of their basic salary. iii) 40% of the basic salary for taxpayers residing in non-metro cities and 50% of the basic salary for taxpayers living in metro cities.
Now, let’s see how Akash can avail HRA exemption. If he is paying a monthly rent of Rs 25,000, then his HRA exemption calculation is as follow:
|Total HRA received (Rs 25,000 x 12)||Rs 3,00,000|
|Total rent paid reduced by 10% of basic salary||Rs 2,40,000|
|50% of basic salary (he is living in a metro city)||Rs 3,00,000|
|HRA exemption||Rs 2,40,000|
|Tax benefit||Rs 74,880|
Section 80D provides taxpayers with tax deductions on the premium paid towards health insurance policies for self, parents, spouse, and children. The taxpayers are can claim the following amounts as deductions under Section 80D: i) Up to Rs 25,000 on the premium for health insurance availed for self, spouse, and children. ii) If your parents are covered under the insurance policy, then a maximum deduction of Rs 50,000 is allowed. iii) If either of your parents is a senior citizen, then the maximum deduction allowed is Rs 75,000.
Now, let’s see how Akash can utilise the provisions of Section 80D to save taxes. He buys a health policy for himself by paying a premium of Rs 20,000. He later decides to cover his parents as well under the policy. He spends an additional Rs 53,000 to do so. Akash’s father is aged 61 years. Hence, he can avail an additional deduction of up to Rs 50,000 towards the premium paid to cover his father. Thus, Akash can claim Rs 70,000 paid by him (Rs 20,000 for covering self and Rs 50,000 for covering parents, one of whom is a senior citizen) under Section 80D this year. He saves Rs 21,840 in taxes under this Section.
Those taxpayers having availed education loans can make use of the provisions of Section 80E to save on taxes. Taxpayers can claim deductions of the interest paid towards education for eight years, starting from the date of repayment. The loan should have been availed from a recognised bank or non-banking financial institution. There is no capping on the deductible amount. The entire amount paid as interest can be deducted from the taxable income.
As Akash has availed an education loan, he is eligible to deduct the interest paid on the same. He has paid Rs 2,50,000 this year as interest towards his education loan. The Section 80E provisions allow him to deduct the entire Rs 2,50,000 from his taxable income. He saves Rs 78,000 in taxes.
Apart from the deduction mentioned above and exemptions, there are several other ways to save on taxes. Donations made towards qualified organisations and charities are eligible for tax exemptions in the range of 50% to 100%. Donations made towards those charities covered under Section 80G are eligible for 100% deduction. The Prime Minister’s National Relief Fund, National Foundation for Communal Harmony, and National Defence Fund are some of the funds that allow 100% deduction.
Tax planning is not as hard as it seems. Every taxpayer should look to optimise their tax outgo. Tax-saving investments should be considered as they not only save taxes but also help in accumulating a corpus which can be used to cover various life events.