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What is Tax Planning – Objectives, Types and Process

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With every paycheck you receive comes taxes. It’s natural to want to save as much of your hard-earned money as possible, and tax planning lets you do just that within the constraints of the law. Not only do you stay compliant by doing your tax planning, but you also further the country’s economic growth and help it develop. In this tax planning guide, we’ll cover everything – From the definition of tax planning to understanding its importance, benefits, process, and different types, exploring effective strategies, and avoiding common mistakes. Let’s go!

What is Tax Planning?

We’ll start with the tax planning meaning. How can you save your taxes? Well broadly, there are three ways people can do so. First is by exploiting tax loopholes or avoiding paying taxes. This is called tax avoidance. One can also deliberately conceal their income or provide false information on purpose. This is called tax evasion. The third way of minimising your tax liabilities is by arranging your finances in such a way that can take advantage of available tax deductions, benefits, and exemptions given by the government to reduce your net taxable income effectively. 

This is called tax planning. Tax avoidance and evasion have very serious legal consequences. Adopting these approaches gets one entangled in legal issues, they face hefty fines, damage their reputation, and destroy the financial stability of their family. That’s why you should always plan for your taxes. It makes sure you are compliant with the law and safeguards your long-term financial well-being, while also optimising your tax savings.

Understanding Tax Planning in India

In India, the Income Tax Act of 1961 governs the taxation of income. Its various sections and subsections contain many deductions, exemptions, and benefits that are used in tax planning for income tax. Maximizing these deductions and exemptions helps one reduce taxable income, which leads to tax savings. Lawmakers often review tax laws to make sure they remain relevant, fair, and effective in achieving their intended goals, so amendments are introduced. But tax planning in India saw a twist with the introduction of the new tax regime in the Union Budget 2020. This new system offers lower tax rates, but one must also forgo the many tax benefits such as the 80C investments by adopting the new regime. These benefits however are still present in the old tax regime. 

Importance of Tax Planning

  • Financial Efficiency: Efficient tax planning allows individuals and businesses to manage their finances effectively, ensuring optimal utilization of resources.
  • Reduced Tax Liability: Proper tax planning helps minimize tax burdens through legal methods, such as utilizing deductions, exemptions, and tax credits.
  • Wealth Accumulation: By investing in tax-saving schemes and investments, individuals can accumulate wealth over time while enjoying tax benefits.
  • Long-Term Goals: Tax planning aligns financial decisions with long-term objectives, such as retirement planning, education funding, and asset acquisition.
  • Holistic Approach: A tax planning and savings optimizer considers overall financial well-being while creating tax-efficient strategies.

Objectives of Tax Planning

Along with risk planning, investment planning, and emergency planning, tax planning forms an integral part of your overall financial plan. With proper tax planning, you can achieve the following:

  • It can help you minimise your tax liabilities legally. This is the main objective of tax planning. This is done by reducing one’s net taxable income by using the various exemptions, deductions, and other benefits allowed by income tax laws.
  • Some individuals use tax avoidance or tax evasion to save their money. Such methods are not only ethically wrong but also illegal. Engaging in these practices exposes individuals to severe legal consequences, such as hefty fines and even imprisonment. With proper tax advice from a tax advisor, one can ensure compliance with tax laws and regulations and avoid litigation.
  • Tax planning can also help individuals create wealth. Since the popular ways to get deductions in the Income Tax Act are the 80C investments, one doesn’t just reduce their taxable income, but the moderate returns from long-term savings instruments such as the Public Provident Fund and ELSS can help you save money for retirement or any other long-term financial goals.

Different Types of Tax Planning Strategies in India

Below are the different types of tax planning strategies based on various aspects such as the duration of the planning horizon and the nature of financial goals. Here they are:

1. Long-term Tax Planning

One begins long-term tax planning at the beginning of the financial year. Let’s take an example. Suppose you start investing in a tax-saving mutual fund, also called an Equity-Linked Savings Scheme. ELSS provides benefits up to Rs. 1.5 lakh under Section 80C. If you opt to take the SIP route, you will commit yourself to making regular and fixed payments throughout the year. 

You will not get immediate tax benefits, but at the end of the year, it will help you lower your taxable income. This is what this type of tax planning does. It doesn’t offer tax benefits immediately, but rather, in the long run. Other ways to do tax planning in the long term include making contributions to instruments such as the Public Provident Fund, or the National Pension Scheme. Long-term tax planning helps investors not only save tax but also helps them accumulate wealth to achieve goals such as a financially stress-free retirement.

2. Short-term Tax Planning

On the other hand, short-term tax planning helps one avail immediate tax benefits. Since it is done closer to the end of the financial year, it often requires investing a large amount in a single go, rather than spreading it out through SIP as one might do in long-term planning. This can potentially disrupt the budget.

3. Permissive Tax Planning

This type of tax planning includes using provisions within the tax law to minimise tax liability. For example, the Income Tax Act of 1961 allows individuals to take advantage of various deductions and exemptions by investing in options under Section 80C. It also allows deductions on premiums paid towards life and health insurance under Section 80C/ 10(10)D and Section 80D respectively. Under Section 80G, one can even get deductions by making donations to charitable or political causes. One can also get tax benefits by repaying home loan interest under Section 24B, and on repayment of education loan under Section 80E.

4. Purposive Tax Planning

When you plan with a particular goal in mind, tax planning is said to be purposive. For example, if you want to reduce your tax liabilities through Section 80C of the Income Tax Act, you might purposefully invest in tax-saving instruments like the Public Provident Fund or National Savings Certificate. However, these investments give benefits up to a limit, and their returns are moderate. With purposive tax planning, one will maximise the benefits given by these instruments by investing up to that limit, and diversify their investment portfolio to include other options that complement their financial goals and risk tolerance.

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Tax Planning Process

Generally, tax planning involves the following steps:

Step 1. Tax planning starts by assessing one’s financial situation. By taking into account total income, expenses, investments, and other assets you can get a big picture of your financial health. Income is the most important aspect to evaluate here. Consider every source of income such as salary, profit from selling assets like mutual funds or shares, interest from bank fixed deposit, freelance work, or profit from a business. 

Step 2. Then, you have to work out which aspects of your income are taxable and which aren’t. For example, for a salaried employee, the House Rent Allowance is a part of the overall package and is a component exempt from tax up to a certain limit. Doing so can help you work out your taxable income and figure out your current tax burden. Only then can you proceed to reduce it. 

Step 3. Next, you need to identify ways in which you can reduce your taxable income. The Income Tax Act provides various exemptions and deductions that can be used to lower your taxable income, such as:

    • Investing in schemes like the Public Provident Fund (PPF), National Pension Scheme (NPS), Senior Citizen Savings Scheme (SCSS), and Sukanya Samriddhi Yojana (SSY) allows you to earn a moderate return on investment while allowing you to claim a deduction of up to Rs. 1.5 lakh under Section 80C.

    • If you have a home loan, you can also claim deductions under Section 80C of up to Rs. 1.5 lakh for the annual income spent on repayment of the principal amount. On top of that, up to Rs. 2 lakh can be availed in deductions for interest payments on home loans under Section 24.

    • If you buy a health insurance policy for yourself, you can get a benefit of Rs. 25,000 on premiums paid under Section 80D. Covering your parent’s health can help you get an additional deduction of Rs. 25,000, which rises to Rs. 50,000 if they are senior citizens. 

    • Life insurance plans also give tax benefits under Section 80C and Section 10 (10D). Investing in Unit Linked Insurance Plan (ULIP) provides an opportunity to avail tax deductions on premiums paid.

    • Section 80E allows you to claim deductions on interest paid on education loans.

    • If you make a charitable donation, you can get deduction benefits under Section 80G. 

    • Up to a specific limit, allowances such as House Rent Allowance (HRA), conveyance allowance, and Leave Travel Allowance (LTA) are also exempt from tax.

    • These are just some examples. One can get over 70 deductions and exemptions under the old tax regime. The new tax regime also offers some exemptions, but they aren’t as substantial as the old tax regime. That’s why it’s important to assess which regime can help you save more before you file your taxes. 

Step 4. Based on your financial situation, goals, and preferences, develop and implement your strategy. This may mean investing in post office schemes, getting insured, or investing in ELSS. A tax planner can help you identify the optimal opportunities that reduce your tax liability while staying hand-in-hand with your overall financial plan. 

Step 5. After you have implemented your strategy, you have to review it regularly. Tax law changes often, which means new opportunities and risks may also arise. Stay updated and reassess your plan annually so you can make sure it stays aligned with your financial goals and continues to maximise tax savings effectively. For example, individuals have the option to switch between the old and the new tax regimes every financial year. If you calculate and compare the tax implications under both regimes beforehand, you can make an informed decision on which one is more beneficial for your specific financial situation in a particular financial year.

So if you are wondering How to Make a tax Plan, you can follow the above steps and get started. Remember, the earlier you start the better because that way you won’t have to make hasty decisions and invest a large lump sum somewhere to lower your taxable income. It will allow you to take the SIP route and slowly build your tax-saving investments without harming your budget.

Benefits of Tax Planning

There are many advantages of tax planning. Here are some of them:

    • With tax planning, you can reduce your net taxable income, thus paying less tax and saving more.

    • It ensures that you stay compliant with the tax authorities and laws, so it helps you avoid penalties and fines.

    • With more savings, you can redirect funds towards achieving your other financial goals, such as investing for retirement, building an emergency fund, paying off debts, and planning for your children’s future.

    • Since it eliminates any fear of litigation, tax planning offers peace of mind.

    • Tax planning helps businesses manage cash flow and optimise their operations for maximum tax efficiency.

    • Your honest tax contribution contributes to the country’s economic growth and helps the government invest in public services, education, healthcare, and infrastructure, ultimately improving the quality of life for the citizens.

    • With the help of a tax planner, not only can you minimise your tax burden and avoid litigation, but also you can find tax-saving opportunities that align with your overall financial plan and goals. Thus, it provides you with the dual benefit of reducing your tax liability while simultaneously optimising your financial strategy for long-term success.

Also Read:Benefits of Tax Planning in FY 2024 -25

Common Mistakes to Avoid when Planning for Tax

    • When minimising their tax burden, people often tend to overlook their overall financial plan. Just because you are focused on reducing taxes doesn’t mean you should neglect other important financial goals. If you make a hasty decision and invest in an instrument that doesn’t necessarily align with your long-term view only to save some taxes immediately, it can prove harmful. 

    • The tax filing process can also be a bit complex, especially if you are adopting the old tax regime as you have to evaluate various deductions and exemptions. Make sure you have all the necessary documents at the time of filing. Lack of proper documentation and incorrect reporting can lead to fines and delays in tax refunds. 

    • Waiting until the last minute can also limit the number of tax-saving opportunities, so it is advisable to start planning for your tax as soon as possible.

    • When in doubt, always consult a tax advisor. What worked for your friends and relatives may not necessarily work for you since everyone has a unique financial situation. 

    • Tax-saving instruments allow you to claim a deduction only up to a certain limit. Don’t invest in such instruments any more than you need to, unless they also align with your financial goals. 

How to Save Taxes in India with the help of Tax Planning?

There are several legitimate opportunities for tax saving in India. Thus, it is important to explore these options to optimize your finances while staying within the legal framework, you could always get help from an investment advisor specializing in income tax savings who can provide valuable assistance. Here are some effective tax-saving options for salaried individuals:

1. Invest in Tax-saving Instruments:

  • Section 80C Deductions: Invest up to ₹1.5 lakh in instruments like Employee Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificate (NSC), Tax-saving Fixed Deposits, Equity-Linked Savings Scheme (ELSS), and more.
  • National Pension System (NPS): Contributions to NPS can provide deductions under Section 80CCD(1) of up to ₹1.5 lakh, and an additional deduction of ₹50,000 under Section 80CCD(1B).
  • Sukanya Samriddhi Yojana: For those with a girl child, this scheme offers tax benefits under Section 80C.

2. Health Insurance Premium (Section 80D):

  • Invest in health insurance policies for yourself, your family, and your dependent parents. You can claim deductions of up to ₹25,000 for self, and family, and an additional ₹25,000 for parents (₹50,000 for senior citizens).

3. Home Loan Interest (Section 24):

If you have a home loan, the interest paid on it is eligible for deductions under Section 24(b) of up to ₹2 lakh per annum.

It’s crucial to note that tax planning should be aligned with your financial goals and risk profile. Consulting a tax-saving advisor or financial expert can help you make informed decisions that optimize your tax-saving efforts while adhering to the relevant laws and regulations

Conclusion

As dutiful citizens, we need to fulfill our tax obligations and contribute to the country’s growth. But one doesn’t need to pay any more taxes than necessary. The government has made provisions in the tax laws to allow us to optimise our tax liabilities through various deductions, exemptions, and other benefits. It is our responsibility to take advantage of these opportunities while ensuring compliance with the law. Through tax planning, one can do all this efficiently, and enjoy greater financial security and peace of mind. The beginning of the financial year provides a wonderful opportunity to start tax planning early, so get started today!

FAQs on Tax Planning

What do you mean by tax planning?

Tax planning is the process of minimising one’s tax liability legally by making use of the various deductions, exemptions, and benefits provided by tax laws. This way, one can optimise their finances, save more of their hard-earned money and achieve their financial goals faster. All while ensuring compliance.

Why is Tax Planning important?

Tax planning is important as it helps you reduce tax burden while ensuring legal compliance. It optimises your savings and helps you realise your financial dreams.

When should I start tax planning?

The best time to start planning for taxes is as soon as you possibly can. The ideal time for tax planning is the beginning of the financial year as it helps you maximise tax-saving opportunities, without straining your budget too much.

Who needs tax planning?

Tax planning is important for any individual or business looking to save as much of their hard-earned money as possible legally. If you earn an income subject to income tax, you can benefit a lot from tax planning.

Can you save taxes in India?

You can save taxes by taking advantage of the many deductions and exemptions given in the Income Tax Act, such as: Investing in tax-saving avenues such as the Public Provident Fund (PPF) and Equity-Linked Savings Scheme (ELSS) to get benefits up to Rs. 1.5 lakh under Section 80C. By claiming deductions on premiums paid on health insurance under Section 80D. By claiming deductions on interest paid on home loans under Section 24, and many more.