When it comes to the payment of taxes, a little planning in advance can reduce burden and help avoid risky commitments
The process of tax paying has always confused and bewildered many. Most individuals in a hurry to save tax, end up getting into commitments which they regret later. Some planning in advance can go a long way in efficient management of individual taxes. A four pronged process will help you take stock of your existing investments and also help you in aligning your tax investments to your financial goals.
Calculating your Gross Total Income (GTI)
The first step would be list down the various sources of income that accrue to you from varied sources. The five most probable types on income may be:
- Salary income – salary includes basic pay, house rent allowance (HRA), annuity, bonus, commission etc. If you have switched jobs in a particular financial year, ensure that you include the salary income from both the employers
- House property – tax is on the annual value of the house property after allowing certain deductions
- Business income – include the profits and gains from any business or profession such as that of a doctor or chartered accountant. Ensure that you deduct all expenses that were incurred relating to the business or the profession
- Income from other sources – any income that is outside the other four heads, such as interest from taxable investments like bank fixed deposits, NSC etc.
Include non 80C expenses that reduce your GTI
There are certain expenses that will reduce your GTI and in turn, reduce your tax liability. These are not necessarily investments, but fall under non 80 C commitments
- Medical insurance (Sec 80D) – premium paid for self, spouse, children and parents qualify for deduction up to Rs.35, 000.
- Interest on home loan (Sec 24) – this section allows a deduction of up to Rs.1 lakh towards interest paid on home loan for a self occupied property. If there is a second property which is let out then there is no cap on the deduction allowed
- Interest on education loan (Sec 80 E) – entire interest amount paid on education loan can be claimed as a deduction under this section. This benefit can be availed only when the repayment starts. There is no benefit for the principal amount repaid and it can be claimed only for eight successive years
- Donations (Sec 80 G) – for donations or charity, 50 per cent to 100 per cent of the amount depending on charity is deductible from GTI. However, this amount should not exceed 10 per cent of GTI
- Other Non 80C – there are certain deductions available for specific cases. For example – Sec 80DD – expenses on the medical treatment of a dependant with a disability
List down existing 80C commitments
The next step is to list down the existing 80C commitments. This will give you clarity as to further investments which will give you tax benefits.
- Renewal premiums – take into consideration the renewal premiums towards all existing insurance policies. Term plans, endowments plans and unit linked insurance plans all qualify for tax deductions
- Home loan principal – the principal component of the home loan equated monthly installments (EMI) qualifies for deductions under section 80C
- Employees’ Provident Fund – 12 per cent of the salary is deducted every month and an equal amount is contributed by your employer and put into a fund maintained by the government or your company’s trust. The contribution currently earns a tax free return of 9.5 per cent, only your contribution towards the fund is eligible for deduction from taxable income
- Tuition fees – parents can also claim a deduction for tuition fees for a maximum of two children. The maximum limit allowed for exemption is Rs.1 lakh under section 80C. However, any payment towards any development fees or donations is excluded
- Public Provident Fund (PPF) – a PPF can be opened by an individual in a bank or a post office. It is a 15 year product which can be extended in blocks of five years. It offers a tax free return which is subject to change every April. Any amount between Rs.500 to Rs.70, 000 is required to keep the account active
The total amount of commitments will give you an idea about the additional investment which needs to be made to avail the total 80C deduction. You have two options, one to enhance your existing investments or choose a combination of tax saver options available.
Watch Out For
In the rush to utilise the entire limit of section 80C, individuals invest in schemes which are poor in performance or the ones that do not suit their goals. Some of the key points to remember are listed below:
Investment into any life insurance policy will provide tax benefit
This is not necessarily so. Insurance Regulatory and Development Authority has laid down certain rules for an
insurance policy to qualify for tax benefit. For instance, the sum assured should be at least five times the premium paid so as to claim 100 per cent deduction under section 80C. Otherwise, you will get a deduction of only 20 per cent of the premium paid. Investors should be particularly wary of single premium products as the mandated life cover is only 125 per cent. Another benefit from this is getting tax free proceeds at maturity.
Paying health insurance premium by cash
To get a deduction under section 80D it is not sufficient if the policy is bought under your name. Care has to be taken to ensure that the payment is not made by cash. This goes to suggest that payments made via credit card and cheque are only accepted as mode of payment for claiming deduction under section 80D. It is important to note that the limit cannot exceed Rs.15, 000 for self, spouse and children. Similarly there is limit of Rs.15, 000 for parents and Rs.20, 000 if the parents are above the age of 65.
Tax benefit for both employee’s and employer’s contribution
Many people assume that both employee’s and employer’s contribution to EPF gets tax benefit. It is not true and only the employee’s contribution can be claimed as deduction. For instance, if your basic salary is Rs.30, 000 then 12 %( 3, 600) each is contributed both by employer and employee. Only Rs.3, 600 can be claimed as tax benefit as this is your contribution.
Tax deductions on entire rent paid
Another mistake committed by most individuals is to include the entire rent paid by them under section 80C. As a matter of fact, rent is not an investment and is just part of your total salary. The Income Tax Act states that the lowest of the following can be claimed as deduction to reduce tax burden:
- 50 per cent of basic salary if you are staying in a metro (40 per cent in case of a non metro)
- Actual house rent paid over 10 per cent of basic salary
- Actual HRA received
Let us understand this with an example:
Assuming your basic salary is Rs.30, 000 and house rent allowance is Rs.10, 000, you pay a monthly rent of Rs.8, 000. You can claim the least of the following as deduction:
- Rs.15, 000 (50 per cent of your basic salary – assuming you live in a metro city)
- Rs.5, 000 (8000-3000 which is excess of house rent paid over 10 per cent of basic salary)
- Rs.10, 000 (actual HRA received)
Thus, the amount that can be claimed as deduction is Rs.5, 000 only.
Tax deduction on home loan interest
If you have taken a home loan then you cannot claim deduction under section 80C for both principal and interest amount paid. For example – if you take a loan for Rs.20 lakh at an interest rate of 9 per cent with an EMI of Rs.17, 995, the interest component will be Rs.15, 000. The balance Rs.2, 995 will be towards principal and only that amount can be claimed as deduction under section 80C.
Thus, as pointed out earlier, a little bit of planning and execution can make the burden of tax planning seem easy. If you have begun tax planning for this year around April, you are probably on the right track. For those who did not, it is never too late. Finally, even after you have made investments and claimed tax breaks, do not forget to keep the records and documents of your investments and tax deduction certificates.