Income Tax Planning

What is Income Tax Planning? 

Tax Planning means planning tax liability by taking benefits of the concessions and exemptions provided in the tax law. It involves the process of arranging business operations in such a way that reduces tax liability.

The purpose of Tax Planning is to ensure tax efficiency in such a way that it will reduce the tax liabilities and give considerable returns over a specific period of time for its investment made to reduce the tax liabilities involving minimum risk.

Considerations of tax planning include timing of income, size, timing of purchases, and planning for expenditures. Also, the selection of investments and types of retirement plans must complement the tax filing status and deductions to create the best possible outcome.

Types of Tax Planning

People generally perceive tax planning as a process that helps them reduce their tax liabilities. However, it is also about investing in the right place at the right time for the future and planning the future risks..

Following are some of the various methods of tax planning:

Short-range tax planning

Under this method, tax planning is thought of and executed at the end of the fiscal year. Investors resort to this planning in an attempt to search for ways to limit their tax liability legally when the financial year comes to an end. This method does not partake long-term commitments. However, it can still promote substantial tax savings.

Long-term tax planning

This plan is chalked out at the beginning of the fiscal and the taxpayer follows this plan throughout the year. Unlike short-range tax planning, you might not be offered with immediate tax benefits but it can prove useful in the long run.

Permissive tax planning

This method involves planning under various provisions of the Indian taxation laws. Tax planning in India offers several provisions such as deductions, exemptions, contributions, and incentives. For instance, Section 80C of the Income Tax Act, 1961, offers several types of deductions on various tax-saving instruments.

Purposive tax planning

Purposive tax planning involves using tax-saver instruments with a specific purpose in mind. This ensures that you obtain optimal benefits from your investments. This includes accurately selecting the appropriate investments, creating an apt agenda to replace assets (if required), and diversification of business and income assets based on your residential status.

Advantages of tax planning:

• To reduce tax liabilities: Every taxpayer wishes to reduce their tax burden and save money for their future. You can reduce your payable tax by arranging your investments within the various benefits offered under the Income Tax Act, 1961. The Act offers many tax planning investment schemes that can significantly reduce your tax liability.
• To leverage productivity: One of the core tax planning objectives is channelising funds from taxable sources to different income-generating plans. This ensures optimal utilisation of funds for maximum returns.
• To minimise litigation: To litigate is to resolve tax disputes with local, federal, state, or foreign tax authorities. There is often friction between tax collectors and taxpayers as the former attempts to extract the maximum amount possible while the latter desires to keep their tax liability to a minimum. Minimising litigation saves the taxpayer from legal liabilities.
• To ensure economic stability: Taxpayers’ money is devoted to the betterment of the country. Effective tax planning and management provide a healthy inflow of money that results in the sound progress of the economy. This benefits both the citizens and the economy.

Who should seek Income Tax Planning?

• Salaried Individuals
• Anyone who requires an expert advice on taxes in optimization, investments or notices
• Freelancers
• Financial Traders
• Business Owners

How to reduce taxes?

Taxpayers are provided with several options to reduce their tax liabilities. Various sections of the Indian income tax law offer tax deductions and exemptions, of which, Section 80C is the most popular tax-saving avenue. For e.g., Deposits in Public Provident Fund , Five Year Bank Deposits, National Savings Certificate , Investment in ELSS schemes.

The best and the most optimum way to save taxes is by laying out a financial plan whenever there is a revision in your income and sticking to it. Also, it is a good habit to make tax-saving investments at the beginning of the year rather than making hasty and often incorrect investment decisions at the last moment. To do this, it is crucial to be aware of all the exemptions and deductions available to you.

Tax saving options under Section 80C

Section 80C, one of the most prevalent sections in the Income Tax Act, 1961, provides provisions to save up to Rs46,800 (assuming the highest slab of income tax i.e. @30% plus education cess 4%) on tax liabilities each year. One of the best tax-saving avenues under Section 80C is investing in ELSS funds, investing in government schemes such as National Savings Certificate (NSC), Public Provident Funds (PPF), tax-saving FDs, etc. apart from Payment of insurance premium and repayment of housing loan instalments. Cumulative investments and payments under these sections can offer deductions up to Rs1.5 lakh.

Tax saving options under Section 80D

Under this section, taxpayers are offered deductions on the premium paid towards health insurance policies. Under Section 80D, a taxpayer can claim the following amounts as deductions:

Avail up to Rs25,000 on the premium paid towards health insurance for self, children, or spouse. Avail up to Rs50,000 if your parents are also covered under your health insurance plan, If either of your parents belongs to the senior citizen bracket, then a maximum deduction of Rs75,000 is allowed

Tax saving options under Section 80E

Section 80E offers tax deductions on the interest paid for an education loan. These deductions can be claimed for eight years starting from the date of repayment. There is no upper limit on the deductible amount. This means that an assessee can claim the entire amount paid as interest from the taxable income.

Claiming HRA Exemption

Under HRA, taxpayers can avail exemption on the cost incurred to stay in a rented accommodation. The taxpayer is mandated to furnish the rent receipts provided by the landlord. The deduction available is the least of the following amounts:

Actual HRA received; or

50% of basic salary+DA (dearness allowance) for taxpayers living in metro cities; & 40% of (basic salary + DA) for taxpayers residing in non-metro cities; or

Total rent paid less 10% of basic salary + DA

Other Exemptions and Deductions

Apart from the deductions and the exemptions mentioned above, you can save taxes in several different ways. Donations towards charities and qualified organisations are also eligible for tax exemptions.

Under the new tax regime announced with the Union Budget 2020, individuals can opt to pay taxes at reduced rates and redefine income tax slabs by forgoing the various deductions and exemptions.

Steps of the tax planning process:

First take into account your total income. This is simply the starting point of the process and involves doing an honest and accurate calculation of your annual and monthly income.

See exactly how much of it is taxable. Your entire take-home pay is not taxable. Some parts of your salary, like allowances for house rent or travel, are not taxable. On the other hand, any profit you make from your investments could add to your taxable income. Thus, understanding your actual taxable income is a must.

Avail deductions to reduce your total taxable income. This can be done through structuring your salary and planning your investments right. For example, profits from a debt fund held for over three years are taxed at 20% after indexation. Interest from a fixed deposit, on the other hand, is taxed at the same rate as your income tax. So if you fall in the 30% bracket, debt funds may be a more tax-friendly option for you.

Lastly, invest some money in tax-saving instruments. For this, you will need to read up on Section 80 of the Income Tax Act. This mentions all tax-related rules. There are many investment options that are available for effective tax planning like Provident Public Fund (PPF), Equity Linked Saving Schemes (ELSS) or National Saving Certificates (NSC). Even your life insurance , health insurance and home loan payments can help you avail tax savings.

All you need is a simple understanding of your own income and some basic tax rules; this little effort can go a long way in ensuring your overall financial security.