Tax planning is the legal method of reducing tax liabilities on your income. Under certain sections and laws of the Government of India's Income Tax Act, numerous schemes serve as tax-saving options for salaried individuals.
In the Income Tax Act, Section 80C, in particular, is a haven containing some of the country's best tax-saving investments. There are four types of tax planning for individuals, purposive, permissive, and long and short-term.
Another avenue of tax planning is tax loss harvesting. What is tax loss harvesting? Suppose you have acquired some capital gain from investments performing well. Under the Income Tax Act, these capital gains are taxable. However, if you have also invested in some assets that resulted in a loss, you can sell these assets at a loss to reduce the tax paid on your overall capital gains. Examples to further detail can be found below.
Understanding Tax Planning
The four types of tax planning are:
- Short-Range Tax Planning: This is on a year-to-year basis. The goal is to complete short-term objectives and retrieve low-risk yearly returns. Investments like Public Provident Fund and National Savings Certificate fall under this category.
- Permissive Tax Planning: These are investments made into schemes permissible under taxation laws like Section 80C of the Income Tax Act. Beneficial investment schemes provide some of the best tax-saving investments.
- Purposive Tax Planning: Under Sections 60 to 65 of the Income Tax Act, it is possible for the income of other persons to be included in the income of the assessee. Finding ways to circumvent this inclusion of other tax liabilities is known as purposive tax planning. This generates more disposable income for the assessee.
- Long-Term Tax Planning: This is the formulation of a financial plan determined at the start of the year and maintained throughout its course. Unlike short-term planning, returns on investments take more time to come in.
Tax Saving Options for Salaried Individuals
- Equity Linked Savings Scheme: ELSS is a mutual fund investment that offers tax benefits on investments (under Section 80 of the Income Tax Act). It is the only mutual fund with this advantage, offering up to Rs 1,50,000 in tax deductions. ELSS is one of the best tax-saving investments, offering more returns than most tax-beneficial schemes.
- Fixed Deposits: FDs offer 3.75% to 9.90% returns per annum; it is a safe and secure investment with guaranteed returns. FDs offer tax deductions up to Rs 1,50,000 under Section 80C.
- Public Provident Funds: PPFs guarantee your return on investment; however, they have a long-term lock period of 15 years. Nonetheless, it is a strong tax-saving option as the annual compound interest on PPFs can provide a respectable return. PPFs come under Section 80C of the Income Tax Act.
- Unit Linked Insurance Plan: ULIP is a two-part plan. Part of your deposit goes into investing, and the other part goes under an insurance plan. ULIP investments can provide sizeable assets, provided you wait 10-15 years to let the investment mature. ULIP comes under Section 10(10D) of the Income Tax Act.
- National Pension Scheme (NPS): NPS is a long-term investment you can begin anytime. You receive your investment back with interest when you turn 60. An individual can avail of tax deductions up to Rs 1,00,000 under NPS, which comes under Section 80 CCD (1B) of the Income Tax Act.
These are only some of the schemes individuals can employ for efficient tax planning. You can consult with an investment planner advisor to learn more.
Understanding Tax Harvesting
As mentioned in the introduction, tax loss harvesting is when you offset tax due on capital gains by selling underperforming assets at a loss. There are two kinds of tax loss harvesting: 1. Tax loss harvesting on short-term capital gains, 2. Tax loss harvesting on long-term capital gains. Capital gains in the short run are taxed at 15%. Capital gains in the long run are taxed at 10% above Rs 1,00,000.
An Example
- Short-Term Capital Gains (STCG): Assume your STCG is Rs 1,00,000 and your STCG loss is Rs 50,000.
Tax paid without tax-loss harvesting: (1,00,000 x 15%) = Rs 15000.
Tax paid with tax-loss harvesting: (1,00,000 - 50000) = Rs 50000, Calculating STCG: (50000 x 15%) = Rs 7500.
- Long-Term Capital Gains: Assume your LTCG is Rs 3,00,000 and your losses are Rs 2,00,000. Remember that up to 1,00,000 gains are not taxable for long-term investments.
Tax paid without tax-loss harvesting: (2,00,000 x 10%) = Rs 20000
Tax paid with tax-loss harvesting: (0 x10%) = Rs 0
Conclusion
Tax planning is an essential aspect of financial planning and wealth management. There are four types of tax planning you can avail to reduce tax liabilities. It is wise to consult an investment planner to determine your best tax saving investments. The Income Tax Act carries many provisions and schemes, such as Fixed Deposits and Public Provident Funds, that are some of the best tax-saving investments.
Another useful tax planning method is tax loss harvesting. Through the example shared, one can see the tax burdens mitigated using short and long-term investment losses.
