March is that time of the year when you feel a sense of foreboding. All you can think of how much you need to pay in income tax. If you are not a salaried person, you will be wondering if you have paid enough advance tax in the right instalments. You’ll also worry about making the right investments or salary adjustments to ensure that your tax outgo is kept to the minimum.
But it needn’t be all that stressful if you realise the importance of tax planning and took proactive measures. That way you don’t have to worry.
One of the benefits of tax planning is that you pay the right amount of tax at the right time. If you are a salaried person, you don’t have to worry about paying income tax on time since the company will do it for you. But if you are self-employed, you will have to make an estimate of how much you are going to earn during the year, calculate how much income tax you need to pay and pay advance tax accordingly. You’ll have to plan in advance how much you expect to earn; you can take an average of the past few years.
You have to pay advance taxes in instalments – 15 percent by 15 June, another 30 percent by 15 September, another 30 percent by 15 December, and the rest by 15 March. If you don’t pay the advance tax instalments on time, you could be charged penal interest of 1 percent per month.
If you are a salaried employee, you have to pay income tax on any other income that you earned during the year, like interest on deposits, rental income etc. Banks deduct TDS on interest income at 10 percent, but that’s not the end of the story. Any interest income is added to your taxable income and taxed according to the slab you are in. So, it’s always better to declare other income to your employer so that it can pay the advance tax accordingly. You don’t have to worry about paying advance tax since it will be handled by the employer.
One of the important benefits of tax planning is that you will be able to ask your employer to devise a pay package that minimises your income tax outgo. For example, basic salary is fully taxable. So, it’s better to keep the basic salary component on the lower side. You can use house rent allowance (HRA) to lower your tax liability since HRA is eligible for certain exemptions under section 10-13A of the Income Tax Act.
HRA deduction is the lowest of these:
Similarly, leave travel allowance (LTA) is also exempt from tax. However, you must note that this is only for expenses incurred on actual travel, not for hotel stay and other expenses. You can claim the amount for yourself and your family members, but you can do it only two times in four years.
There are other components of your salary that are exempt from income tax. These include medical expenses (up to Rs 15,000 actual expenses), children’s education, conveyance allowance, research allowance, meal vouchers etc.
So, when you realise the importance of tax planning, you will be able to negotiate with your employer to get a much more tax-friendly pay package.
One of the advantages of tax management is that you will be able to invest in instruments that reduce your tax liability. Most tax-savvy investors will have heard of Section 80C of the Income Tax Act. Under this section, certain investments are eligible for a reduction of taxable income to the extent of Rs 1.5 lakh per annum. So by making investments in these, you will be able to reduce your tax burden considerably. For example, if your income is Rs 10 lakh, you will have to pay income tax of Rs 1.17 lakh. If you invest in Section 80C instruments, you will be able to reduce your taxable income by Rs 1.5 lakh to Rs 8.5 lakh, in which case your tax burden will be Rs 85,800. Your next income tax saving: Rs 31,200!
So by investing in the right instruments, you will be able to fully realise the benefits of tax planning. Here’s a brief look at some of your Section 80C options:
Public Provident Fund (PPF): A PPF should form an integral part of your investment portfolio. It is what is called an EEE (exempt, exempt, exempt) instrument in terms of tax benefits. Which means that the investment that you make, the interest earned and the maturity proceeds are all exempt from tax. Yes, the interest rates may not be all that great (around 8 percent), but you must remember that they are not bad compared to those from other fixed income instruments. Besides, you must have some amount of debt in your portfolio to ensure that it’s adequately diversified. The disadvantage of PPF is that it has a very long lock-in period – 15 years. So it’s better to realise the importance of tax planning at an early age to enjoy its full benefits!
ELSS funds: Another investment choice to reduce your taxable income could be ELSS or equity-linked saving schemes. These are basically equity funds, and investing in them will reduce your taxable income to the extent of Rs 1.5 lakh. They are a good choice if you are willing to bear a higher level of risk, since equity generally offers higher returns than fixed income instruments. However, there is a lock-in period of three years and returns from ELSS funds are subject to long-term capital gains tax at 10 percent.
Five-year fixed deposits: Certain deposits by banks are eligible for tax deduction under Section 80C. However, there is a lock-in period, and interest earnings are subject to tax.
National Savings Certificates (NSC): NSC is also eligible for Section 80C deduction. You can invest in them through the local post office. They come with a lock-in period of five years, and interest is taxable. However, since the interest is reinvested in the scheme, you can add the interest component to your Section 80C investments and pay no tax on it.
Insurance: Insurance payments can also help you reduce your tax outgo. Under Section 80C, premiums on life insurance can be deducted from your taxable income to the tune of Rs 1.5 lakh. However, the insurance cover has to be ten times the premium paid. Health insurance is also eligible for tax benefit. You can claim a deduction of Rs 25,000 a year on premiums paid for yourself, spouse and children under Section 80D. An additional Rs 25,000 is available for premium paid for parents.
Another one of the advantages of tax planning is that you pay the correct amount of tax and avoid entanglements with the Income-Tax Department. As anyone who has had the experience of pleading their case with the department can testify, this is a headache you can do without. Proper tax planning will help you pay the right amount at the right time.
Returns from some kinds of investments are added to your income and taxed according to the slab you are in. These include interest earned on fixed deposits and short-term capital gains on debt funds. Tax planning will help you spread out your investments so that your tax burden does not fall disproportionately in one year.
If your fixed deposits mature in one particular year, all the interest will be added to your taxable income and you could end up in a higher tax bracket and pay more income tax. Let’s say for example, your income is hovering around the Rs 9 lakh mark, and you find that a lot of your FDs are maturing that year, earning you a sum of Rs 2 lakh in interest. Thus, your taxable income will go up to Rs 11 lakh. In that case, your income will go up from the 20 percent bracket to the 30 percent bracket. So your tax outgo will be much higher.
“Nothing is certain but death and taxes” goes the saying. Like it or not, you will have to pay taxes. No one likes paying taxes, but you need to pay them to keep the engine of government moving, to ensure law and order, and for building roads, bridges and other infrastructure. It is the price we have to pay to live in an orderly society. However, the tax authorities have given you many ways of reducing your tax burden legally, and tax planning will help you do that.