tax planning

Do you plan your taxes? How to save money grow wealth!

Its January already. How fast the years flown. Christmas is the season of gifting. So I was thinking of what I could gift you guys.  And thinking of, it How about I gift you some money. Well at least tell you how you can save some money so that you can enjoy it.

Tax planning

Every year the government of India via the budget tells you how you are going to be taxed. Now there are different ways the government will tax you. There’s direct taxation and indirect taxation. A lot of the indirect taxes have been recently brought under the umbrella of the GST. But that’s not the kind of tax I’m talking about. I’m talking about personal income tax.  Each of us has to file our personal income tax at the end of the year.  

So what is tax planning? Well Investopedia defines tax planning as “Tax planning is the analysis of a financial situation or plan from a tax perspective. The purpose of tax planning is to ensure tax efficiency. Through tax planning, all elements of the financial plan work together in the most tax-efficient manner possible. Tax planning is an essential part of a financial plan. Reduction of tax liability and maximizing the ability to contribute to retirement plans are crucial for success.”

For me a simplified version of tax planning would be:

  1. Going through the relevant sections of the budget and finding the sections/ rules/ perks applicable to you
  2. Understanding the perks / incentives the government  has allowed for the relevant sections
  3. Plan and implement a savings/ expense plan to optimize your tax outlay. 
  4. Figure out the value of taxes you owe

The Cheat Sheet

If you just want to know what the tax slabs are and what my suggestion for tax savings based on your income are, that’s right here. If you want to see some of the sections you can save taxes under keep reading.

Tax slabs for financial year 2020

There are the tax slabs for individual tax payers.

Assessment Year 2019-20

Taxable Income Tax Rate
Up to Rs. 2,50,000 Nil
Rs. 2,50,000 to Rs 5,00,000 5%
Rs. 5,00,000 to Rs. 10,00,000 20%
Above Rs. 10,00,000 30%

Less: Rebate under Section 87A [see Note]

Add: Health and Education Cess [see Note]

https://www.incometaxindia.gov.in/Pages/charts-and-tables.aspx

Tax planning for salaried individuals.
This is going to be a simplified version of a decision tree of what you need to invest in and how much to optimize your tax outgo. I’m going to be using the simple benchmark of taxable income as compared to gross income. The reason I’m going to be doing this is structuring your salary to reduce taxable income is a whole different ball game and depends a lot on the individual situation. That’s best done with a tax consultant or through your own research. So anyways here goes.

Activities that can save you tax and the relevant Sections

Lets have a look at some of the sections that will allow you to reduce your tax outlay.. This list is priortised from highest priority to lowest. It starts with payments that you would ideally be already making and moves on to discretionary savings / spends that you could choose to make.

1.Exemption against rent paid (Section 80GG)

Maximum benefit you can claim: INR 60,000

The benefits of this section are limited to people who do not get paid HRA (House Rent Allowance). So if you are working for a small company or are self-employed and you are paying house rent you might be eligible.

The deduction is available for the least of:

  1. 25% of your total income (excluding capital gains)
  2. Actual rent minus 10% of your income
  3. 60,000 a year

You cannot claim benefits under this section if:  to you if you own a house in the current city and are renting a different place at the same time. You are receiving HRA from your organization. You own a house in a different city and are claiming tax benefits for the same. For example under section 24 (b) 

2. HRA (House Rent Allowance) (Section  10 (13A))

Maximum benefit you can claim: No Limit

So you work for a big multinational and get paid HRA. You lucky dog you. Well here’s how your HRA can reduce your taxable income.

Section 10(13A) has no upper limit to claim HRA exemption.

The deduction is available as the least of:

  1. 50% of your basic salary (40% if you live in a non-metro cities)
  2. Actual HRA received
  3. Actual rent paid -10% of the basic salary

You cannot claim benefits of this section if : You are self-employed.

Documentation you will need:  Rent receipts and Rent Agreement copies as well as mention the PAN number of your landlord in case you annual rentals are over 1,00,000 INR

3. Medical Treatments ( Section 80 DDB)

Maximum benefit you can claim: INR 40,000 for Individual tax payers upto INR 1,00,000 for senior and super senior citizens.

This is a specific exemption for expenditure incurred on treatment for specified diseases. The expense can be on treatment for the taxpayer or one of their dependents. Dependents are limited to Parent, spouse , Children or siblings. A certificate may be required from a senior doctor. Please check the specific requirements for the relevant section

4. Interest on Education loan (Section 80E)

Maximum benefit you can claim: No limit. Total interest component of the education loan EMI paid in the financial year can be claimed.

You can only claim the benefits of this section if you are an individual taxpayer. The purpose of the loan should be to pursue higher studies in India or outside. Th loan can be taken for the higher studies of yourself, spouse or children.

This exemption is available only for a period of 8 years starting from the first year in which you start repaying the loan.

5. Home Loan Interest Section 24

Maximum benefit you can claim: INR 2,00,000

If you are an individual and have taken a home loan, then you can use this section to claim a deduction of up to INR 2,00,000 per year on the interest paid in that year.

You cannot claim the benefits under this section if: The loan had been taken before 1st April 1999. Or the construction/ purchase was not completed within a period of 5 years from the end of the financial year in which loan was taken. Or there is no interest certificate for the interest payable on the loan

6. Health Insurance ( 80D)

Maximum benefit you can claim: Premium for Self spouse and dependent children  INR 25,000 additional for premium of dependent parents INR 25,000

As an individual you can claim a deduction of up to INR 25,000 a year for p[premiums paid towards insuring  yourself, spouse and dependent children. You can claim an additional amount of up to INR 25,000 for the premium paid towards insuring health of dependent parents.

IMHO everyone should get health insurance to cover yourself and your family. The earlier you start the lower the premiums. Additionally if you have preexisting diseases the insurance company can refuse to cover you or can take up to 2 years to provide you cover for a preexisting diseases. Don’t delay get covered today.

7. Long term Savings Section 80C

Maximum benefit you can claim: INR 1,50,000

The Big Kahuna. This is the section everyone thinks of when they think of tax savings. Probably this is the section that most people selling financial products want you to buy into.  But its not the only one out there. And some of the other sections might be way more efficient in reducing you tax outgo with minimal impact on cash flow so choose wisely.

There are a ton on instruments that you can use to claim deductions under 80C These include

  1. Principal repayment of Home loan
  2. EPF ( Employee Provident Fund)
  3. PPF ( Peoples Provident Fund)
  4. ELSS (Equity linked saving schemes)mutual fund tax saver schemes
  5. Insurance Premium  under Section 80CCC
  6. Pension Contribution under section 80CCD

8. Deduction for Rent paid ( 80GG)

If you do not receive HRA as part of your salary, and you pay rent towards a residence for yourself, you can claim relief under section 80 GG. You can claim this benefit subject to fulfilling the following conditions:

  1. You are self employed or salaried.
  2. You have not received HRA at any time in the year you are claiming benefit under 80GG
  3. You / your spouse / your  minor child do not own any residential accommodation in the area you currently stay in.
  4. You have not claimed for any benfefit from income from house property ( as self occupied)
  5. You submit for 10BA with details of payment of rent.

For calculation of the benefit the lowest of the following would apply.

  1. Rs, 5,000 Per month
  2. 25% of total income ( excluding some forms of income. Please read the relevant sections)
  3. Actual rent less 10% of Income

9. Specified Donations ( 80 G)

Contributions made to certain relief fund and charitable funds can be claimed under section 80 G.

Taxable Income from 0 to 2,50,000 suggestions

Wohoo here’s for the good news. You don’t have to pay any tax this year. But remember to file your taxes by the due date. Despite not having to pay tax I would highly recommend that you get a personal health insurance policy. The premium of the health insurance policy is deductible under section 80 D. I would also recommend that you try to increase your income so that you can build an investible surplus.

Taxable Income from 2,50,000 to 5,00,000 suggestions

So we are going to have to pay taxes. But hang on a minute if your taxable income is low enough there are savings that await you. It gets a little tricky so here goes. If your taxable income is above 2,50,000 but  below 3,50,000 INR. You file taxes as usual and calculate taxes as usual, but you can claim a rebate under section 87 A. This is limited to INR 2,500 or the entire tax liability up to 3, 50,000 whichever is lesser. For the others you have to pay taxes for your income between 2, 50,000 and 5, 00,000 at the rate of 5 %

Let’s take a few examples to understand this

Case 1. Your taxable income is 3,00,000 and you’re not showing any savings. Let’s calculate your tax liability.

For income from 0-2, 50,000 tax payable 0

From 2, 50,001 – 3, 00,000 tax payable at 5%

So that’s 3, 00,000-2, and 50,000 X 0.05= 50,000 x 0.05 = 2500

Less Rebate under section 87A of 2500 = 2500-2500 = 0

Case 2. Your taxable income is 3,49,000 and you’re not showing any savings. Let’s calculate your tax liability.

For income from 0-2,50,000 tax payable 0

From 2,50,001 – 3,49,000 tax payable at 5%

So that’s 3,49,000-2,50,000 X 0.05= 99,000 x 0.05 = 4950

Less Rebate under section 87A of 2500 = 4950-2500 = 2450

Case 3. Your taxable income is 3,51,000 and you’re not showing any savings. Let’s calculate your tax liability.

For income from 0-2,50,000 tax payable 0

From 2,50,001 – 3,51,000 tax payable at 5%

So that’s 3,51,000-2,50,000 X 0.05= 1,01,000 x 0.05 = 5050

Since income is over 3,50,000 No Rebate under section 87A of 2500

So final tax liability of 5050.

Basically if you’re taxable income is INR 5,00,000 your liability will be 12,500

Taxable income from 5,00,000 to 10,00,000 suggestions

If your income is between 5L to 10L great going your income is decent. But now its time to optimize your taxes and create/protect wealth.  I would recommend you focus on the following areas

  1. Get a great health insurance policy for you and your family 80D
  2. Try to max out your benefits if you are repaying a home loan or education loan
  3. Look to max out your investments under 80 C ( if your young all equity)
  4. Meet a tax professional and plan out your taxes for the next financial year
  5. Check if there is a chance to structure yourself as an individual or firm that benefits you and reduces you tax liability.

Taxable income from 10,00,000 + suggestions

So your making the big bucks. Congratulations on making it all the way to the top. But remember that also means you’re probably paying a ton of your income as taxes. Here’s what I would recommend.

  1. Get a great health insurance policy for you and your family 80D
  2. Aggressively pay down debt. Don’t let lifestyle inflation get to you.
  3. Try to max out your benefits if you are repaying a home loan or education loan
  4. Look to max out your investments under 80 C ( if your young all equity)
  5. Meet a tax professional and plan out your taxes for the next financial year
  6. Check if there is a chance to structure yourself as an individual or firm that benefits you and reduces you tax liability.

And that’s it. If all you need is a ready reckoner. You’re done. If you’d like to read about my disastrous path of ignoring tax planning you can read on.

A Corporate slaves tax planning strategy

Let me explain how I used to approach my taxes back when I was working for a big corporation.

Start of the financial year: At the start of each financial year the HR/ Finance department will send you a mail asking you to structure your salary. This will include details of any tax saving instruments you wish to invest in and how much you will invest in each.  IF you are like me you will almost always ignore this mail. There will always be a million things more important that are on your plate at this point of time. So the default values will get fed into the system. This usually means you show no tax saving investments being made and being taxed on almost your entire taxable income. This also usually means a direct hit in your take home salary as there probably will be a large amount of TDS (Tax Deducted at source) from day one.

December the holiday season comes calling:  Close to December you will probably receive another mail from Finance asking you to provide documentary evidence of the tax savings you have made over the year.  Again if you’re like me you will have ignored this mail. There will be pressure to finish work to meet project deadlines after all you work for a big corporate and the holiday season comes calling. Plus with being as busy as you were for the rest of the year it was highly unlikely that you’d actually managed to go about saving taxes.

The Shit hits the fan in Jan:  Your Jan salary gets credited and you wake up to a rude shock. It seems like everything you earn is being deducted as TDS. You barely have enough to pay the rent and get to office. Unfortunately it’s too late to do anything. The company has frozen the window to show tax savings and you have to live with this for the next 3 months.   Then for the next 3 months there’d be a shit load of TDS deducted because we hadn’t provided any proofs.

The end of March Reality comes calling: Towards the end of March you’re struggling to figure out where to invest your money. The markets are usually higher than ever because of a great budget and you feel there’s no point in investing in equities at such high valuations. You don’t really have the time to assess pros and cons so you’ll dump a large amount of money into schemes that have large lock-ins. Or if God forbid into a ULIP (Unit linked Insurance Policy). Sigh. But at least you made the delaine and showed some tax savings.  I used to wake up and worry about where to invest I would work out a ball park figure and dump money into random investments be it ELSS or PPF or the like.

Living in panic in July:  Every day as you’re driving you’ll hear ads on the radio saying tax filing deadline is approaching. But do you pay attention? Noooo. You wait till the very last day and then scramble to find documentation to support your deductions. Your stressed out because the website is slow (all the other corporate slaves are trying to file their taxes) you’re not sure if you need advice from a tax consultant. You’re scrambling. But you finally mange to file your taxes and you relax.  There are 2 scenarios here. By some miracle you’ve made enough investments and are eligible for a refund. Or you’ve messed something up and have to pay additional tax with a penalty.

Then you sit and pray for the CPC to clear your refund request and if it went through you might receive your refund back in September. NO wonder I was stressed out all of the time as corporate slave. More than the corporates it shows that we are slaves to our own bad habits.

How to ease your tax worries

After I got out of corporate life I realized how stupid this cycle was. In March I used to receive less than half my total salary, so it was difficult to make the tax saving investment for a lack of cash flow. If I better managed it, cash flow through the year could be significantly better.

So the best modus operandi would be to take some time out in march itself ad calculate your tax liability. Play around with the salary structuring sheet and see if you could reduce your taxable income by tweaking each of the sections.  After deciding on structuring the next step was to make the additional tax savings investment other that EPF on the first day of April. That’s right first day of the new financial year. And send the investment proof to HR/ Finance. After that you didn’t have to worry about liquidity for the rest of the year. Plus it was one less decision to make. One less item to procrastinate for the rest of the year. And it worked beautifully. I was more peaceful my cash flows were more stable. I I knew there was not shock waiting for me at the end of the year. Afterall we are creatures of habit. And tiny changes like these can go a long way in helping us improve our physical and metnal health.

What’s been your experience with filing taxes?. Do you get stressed or is it a breeze. Let me know in the comments below.

Disclaimer: I am not a tax professional and this is my understanding of the individual taxation in our country. Do not treat this as professional advice. Do your own calculations and research and talk to a tax professional if need be. All the calculations are made on a best effort basis. They are simplified and do not include components such as cess.

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