Let’s begin with the meaning of tax planning.
Tax Planning refers to analyzing our financial situation and planning our finances in a manner that will maximize tax benefits and minimize tax liabilities.
India is a country where we all pay a LOT of tax, as most of you know, and hence it is ideal if we plan out our finances to cut down on our tax expenses, which can be done efficiently through tax planning.
The Different Types of Tax Planning
There are several methods by which you can plan your taxes, and these are a few commonly used ways:
- Short Term Income Tax Planning: Here, you figure out your finances and taxes, close to the end of the financial year, and make the necessary investment just before filing charges. This, however, may lead to hasty decisions that may not be the best deal for you.
- Long Term Income Tax Planning: Beginning your planning process at the very start of the financial year is called long term tax planning. This is the ideal method to plan your taxes.
- Purposive Income Tax Planning: Planning your taxes with a purpose to gain maximum benefits is called purposive tax planning. Saving, investments, etc. is made to take maximum advantage of tax benefits.
- Permissive Income Tax Planning: Figuring out all the taxes that are permissible under the law and ensuring to avail those benefits is called permissive tax planning.
You may adopt any method of your choice. However, the key is to ensure you file and pay your taxes without fail.
The 5 steps of Tax Planning:
Tax planning covers several considerations. Considerations include timing of income, size, and timing of purchases, and planning for other expenditures, planning your investments, etc. However, always remember that unforeseen circumstances may arise, no matter how much you may anticipate, but this is part and parcel of life. But being prepared to some extent is always a good idea:
1. Calculate your total income
So our primary source of income is, of course, your salary, which comes from being employed. If you are an entrepreneur, it’s the amount you make as profits. You must also take into consideration earnings like capital gains from investments, properties you have given out for rent, and other such incomes. The total amount will be your annual income.
2. Figure out your taxable income
Taxable income refers to pay which can be taxed, whereas nontaxable income is the amount that is exempted from taxes by the law.
To identify the various nontaxable parts of your income, for example, claiming the following allowances will reduce the amount of income that is taxable:
- House Rent Allowance (HRA)
- Leave Travel Allowance (LTA)
- Medical reimbursement
- Meal allowance, etc.
Figure out various other elements of your income that can be exempted from taxes. Refer to this article for a list of some of the nontaxable incomes in India.
3. 8- Methods of tax planning
There are several modes of investment which in turn can be converted into savings, as they qualify for a tax deduction. Under Section 80C of the Income Tax Act, the following investments are considered nontaxable:
- Public Provident Fund (PPF)
- Life insurance
- Equity-linked savings scheme (ELSS)
- Fixed deposits
- National Savings Certificate (NSC)
- National Pension Scheme (NPS)
- Home Loan ( If you are repaying principal and interest amounts)
- Saving account interest ( up to Rs.10,000) etc.
There are more such deductions which you can discover upon some research, here is a link to get you started.
4. Other smart ways to save more tax
There are several smart ways to get more tax deductions. For example, you may get the help of your family and act wisely. If you live in a property owned by your parents, pay rent and get it deducted as House Rent Allowance. You could invest in your spouse’s name ( with consent, of course) in the tax-saving instruments mentioned above. Pay health insurance for yourself and your family member, which again can lead up to about Rs.60000 in savings.
Thus, think on your toes in order to maximize your savings with the help of your family.
5. Documents and deadlines
Always stay organized as it still works to your advantage in the long run, in the case of finances. The tax personnel could ask you for documents from the past seven years if you have been earning for that long. Also, keep track of the deadlines by which tax needs to be filed every year. It usually falls on March 31st every year, except under unforeseen circumstances.
Ensuring you file all the taxes before deadlines avoid delayed payment fees and confusion in the future as well.
FAQ’s on tax planning
1. When do I start paying taxes?
If your Annual income exceeds 2.5 Lakhs, and if you are below the age of 60, then you need to pay income tax.
2. What happens if I don’t pay tax?
There are various penalties for not paying taxes, and it is usually determined by the Income Tax Officer. For example, a 50% penalty for under-reporting your income, 10% for undisclosed income, etc. If it is intentionally carried out for a long number of years, you could also be jailed.
3. What is Tax Avoidance?
Arranging your finances in a manner where you get the tax benefits unethically, or in an unacceptable way is called Tax Avoidance. This is highly unethical, but many people do this, defeating the very intention of creating tax benefits. This isn’t a punishable offense but is considered wrong in the eyes of the public and the government.
4. What is Tax Evasion?
Evading payment of taxes is known as tax evasion, and it is most definitely a punishable offense. You could even be sent to jail for fraud.
5. If I contribute to a charity, will that amount be exempted from taxes?
As per Section 80G of the Income-tax Act, an individual can claim deductions up to a specific limit for contributions or donations made to charitable institutions or Non-Governmental Organizations. This is genuinely an excellent way to spend some money while availing of tax benefits.
6. Do NRIs also have to pay income tax?
If you have no source of income or capital gains coming from India, then you need not file any taxes. However, if you do have investments or accounts in India that are generating some sort of income, and if the income exceeds 2.5 lakhs, then you have to file taxes as well.