What is Tax Planning?
While taxes are widely considered as a necessary evil for the government to be able to have funds to run the state or country, it can become more than cumbersome to handle the amount of taxes that eat into your earnings or salary. This can cause a dip in your lifestyle, savings, and plans for your financial future.
To counter this, an efficient analysis of your financial situation from the perspective of taxes will be required. This analysis is commonly referred to as 'tax planning'.
It is important to note that tax planning is absolutely legal and governments all over the world provide provisions to help you in your tax planning. This planning aims at reducing your tax liabilities using exemptions, rebates, and other tax benefits as much as possible. Do not confuse this with tax evasion - which is the usage of illegal methods like hiding income, not reporting cash transactions, using offshore bank accounts to avoid paying taxes to your national government, etc. This is strictly forbidden and being guilty of tax evasion can land you a hefty prison sentence.
Why should we plan our taxes?
Apart from taking care of your financial health, an underappreciated advantage of tax planning for individuals is the ability to use the amount saved to be directed into long-term investments. Investing this saved money can generate more money to flow through the economy, contributing directly to the country's development while making your financial situation better.
Types of tax planning
There are broadly four major types of tax planning that are followed by the financially educated folk. These include:-
Short-term tax planning: It is thought of and executed at the end of the fiscal year. This method is done in an attempt to search for ways to limit the tax liability legally when the financial year comes to an end, without considering long-term commitments. This plan does promote substantial tax savings in the short term that certainly adds up over time.
Long-term tax planning: The plan is made at the beginning of the fiscal year and the taxpayer will be following it throughout the year. Compared to short-term tax planning, the likelihood of rapidly growing benefits is slimmer but tends to be useful in the long run.
Permissive tax planning: A careful and delicate plan is made such that taxes can be saved using various provisions provided by the Indian government itself, such as deductions, exemptions, rebates, incentives, etc. Section 80C of the Income Tax Act, 1961, for example, offers various types of deductions to provide tax-saving benefits.
Purposive tax planning: You are saving money from taxes for a specific purpose in this type of tax planning. This may require you to select new assets, replace assets if necessary and diversify any business or income assets.
Most prudent tax planners use most, if not all, of these personal tax planning methods to ensure they are in command of their finances.
How to get started with tax planning?
To begin your income tax planning process, you need to accurately assess your annual and monthly income so that you can clearly identify where you may be required to pay any income taxes. You'll then need to learn and understand all the taxable and non-taxable portions of your income. For instance - your rent allowances in your salary on top of the base pay isn't taxable, while any profits made from financial trades or investments are likely to contribute to your taxable income.
Once you are aware of all the taxable and non-taxable portions of income, use deductions to reduce the overall taxable income.
By clearly structuring your salary and planning your investments properly ahead of time, this can be efficiently done. For example, if you happen to fall in the 30% tax bracket on income over 10 lakhs and above, debt funds are a more tax-friendly option over fixed deposits as debt funds tax 20% on your returns while the latter tax 30% on any returns on your investment.
You must also actively look to invest in instruments that are set-up to encourage investors to plan their taxes ahead of time using deductions available in Sections 80C through 80U of the Income Tax Act, 1961. Other options like the Provident Public Fund (PPF), Equity Linked Saving Schemes (ELSS) in mutual funds, National Saving Certificates (NSC), National Pension Scheme (NPS), etc. Even insurance policies like life and health insurance premiums can be utilized while tax planning for individuals.
Any financially secure individual will look to ensure they can minimize their tax expenditure as much as possible using legal personal tax planning methods looking at short-term, long-term, permissive, and purposive planning. This capital can be used to invest in assets and schemes that will directly help in the flow of the economy and the development of the national economy. One will have to identify their sources of income, distinguish taxable and non-taxable income sources, and appropriately look to identify the best way to reduce taxable sources.
Tax Planning - Frequently Asked Questions
1) Is Life insurance or NPS more tax-efficient at the final payout stage?
Life insurance payouts are tax-free, while NPS withdrawals are taxable as per the income tax slab you come under
2) Isn't tax exemption illegal?
No. Tax exemption or avoidance is legal and is supported by national governments around the world to reduce your taxable income. However, tax evasion is illegal and will require you to carry heavy penalties if found guilty.
3) Should I get expert advice at tax planning or should I do it myself?
It depends on your income level and sources. Most people can avoid the expenses of hiring a professional to plan their taxes and do it themselves but if it gets too complicated, hiring a professional is recommended.
4) What are the tax deductions available under Section 80D regarding health insurance?
Under Section 80D, deductions are offered on the premium paid on health insurance policies. These deductions include:-
a. ₹25,000 on the premium paid towards health insurance for self, children, or spouse
b. ₹50,000 if policyholder's parents are also covered under your health insurance plan
c. A maximum deduction of ₹75,000 if either of the policyholder's parents belongs to the senior citizen bracket.
5) Should I feel guilty about not doing my duty as a citizen to pay my taxes?
Reducing your taxes is a constitutional right and is regularly encouraged by the central government in many countries across the world, provided it's done legally and helps more money flow through the economy. In fact, many of these methods will help our nation grow faster financially, while cutting down on your taxes.
Also, on a side note, there are so many other ways you can fulfil your duty as a law-abiding citizen, like following basic rules and etiquette, helping the underpriviledged and being a good person to your countrymen and countrywomen in general.