How to Plan your Taxes: The Process and the Benefits

How to Plan your Taxes: The Process and the Benefits

Rain Team

June 14, 2022

Tax planning is a crucial action completed by every person earning through salary, professional or other activities and organizations in India. It is vital for budgetary efficiency. A proper financial plan is a must in order to deliver maximum tax efficiency. Moreover, paying taxes is a method of contributing to the country's development.

But before we get into the details, let's first understand tax planning. 

Tax planning is the analysis of one's financial condition from a tax efficiency point of view to plan one's finances in the most optimized manner. Tax planning is a legal way of reducing income tax liabilities; however, caution has to be maintained to ensure that the taxpayer isn't knowingly indulging in tax avoidance or tax evasion.

Tax planning is about making financial and business decisions to minimize tax incidence. It enables one to think of their finances and taxes at the beginning of the fiscal year instead of leaving it to the eleventh hour.

The benefits

Taxes can eat up your annual earnings. Tax planning is a legitimate way of reducing your tax liabilities in any given fiscal year to counter this. Tax planning enables the taxpayer to legitimately avail the maximum benefit by using all beneficial provisions under tax laws, i.e. tax exemptions, tax rebates, deductions and benefits, to minimize their tax liability over a fiscal year. There are some primary purposes of tax planning: 

  1. To minimize litigation: Tax Planning coordinates the provisions under taxation laws, thereby minimizing any litigation. Minimizing litigation saves the taxpayer from legal liabilities. (Litigation refers to settling tax disputes with tax authorities.) There is often conflict between tax collectors and taxpayers as the former attempts to extract the maximum amount feasible while the latter wishes to keep their tax liability to a minimum. 
  2. To reduce tax liabilities: Every taxpayer hopes to reduce their tax burden and save money for their future. You can reduce your payable tax by positioning your investments within the different benefits offered under the Income Tax Act, 1961. The Act provides many tax planning investment schemes that can significantly lessen your tax liability. Tax planning reduces tax liability by saving the taxpayer the maximum amount of tax by arranging their financial operations according to tax decisions. 
  3. To leverage productivity: One of the core tax planning objectives is channelizing funds from taxable sources to various income-generating plans. This guarantees optimal utilization of funds for productive causes. One of the most noteworthy benefits of tax planning is that the returns can be directed to investments. It is the most effective way to make intelligent investments while fully utilizing the resources available due to tax benefits.
  4. To ensure economic stability: Taxpayers' money is devoted to the country's refinement. Adequate tax planning and management provide a restorative inflow of white money that results in the excellent progress of the economy. This helps both the citizens and the economy. Investing tax money helps generate white money to flow through the economy, aiding in the country's economic development. Tax planning hence contributes to the financial stability of the individual and the nation.

But how does one start with Tax Planning?

Don't worry! The process is relatively simple, and anyone can start planning their taxes in a few simple steps:

1. Consider your total income

 This is the starting point of the tax planning process. You are required to accurately assess your monthly and annual income.

2. Evaluate all the taxable aspects of your income

Rent and housing allowances are included in the salary on top of base pay and are not considered taxable. However, profits made from investments may add to taxable income. Hence, understanding one's taxable income is a requisite to plan taxes.

3. Use deductions to reduce the total taxable income.

This can be done by proper planning of investments and structuring salary. For instance, the interest from a fixed deposit is taxed at the same rate as income tax, while a debt fund held over the same number of years is taxed at 20%. So if you fall under the 30% tax bracket against the taxable income of 10 lakhs or above, debt funds are a more tax-friendly option for you.

4. Invest in tax-saving instruments

A wide range of deductions is available to eligible taxpayers under section 80C through section 80U of the Income Tax Act, 1961. Investment options include Equity Linked Saving Schemes (ELSS) in mutual funds, National Saving Certificates (NSC), Provident Public Fund (PPF), or 5-year bank deposits. Life insurance, health insurance premiums and home loan payments can let you benefit from tax savings.

Let's take a simple example, if an individual's income is 7.5 lakhs per annum and they invest 2.5 lakhs in the notified schemes, they can bring down their taxable income to 5 lakhs - consequently reducing tax liability to NIL. These savings can then be put to productive use in the form of investments. Planning your taxes ensures your overall financial security by simply assessing your income and some basic tax rules.

Tax planning has multiple advantages and a very few disadvantages. It should be done within the applicable limits of tax laws and clearly distinguished with tax evasion or tax avoidance, both of which are not acceptable under the appropriate limits of tax laws. Also, any new changes in tax laws should be kept into consideration. For instance, there are currently two different tax regimes in India with different rules & slabs. 

However, tax benefits can only be availed up to a specific limit as per the thresholds fixed by the government tax laws. Yes, there are several tax-saving financial products available in the financial markets, but those products should be evaluated thoroughly with pros and cons before buying and whether they can actually lead to tax savings or not.