The basics of income tax. Plan for the year ahead in 5 minutes.

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Have you just started your first job or are you planning to file your first income tax return this year but have no clue about it? Let me tell you that you’re not alone! Every April marks the beginning of a new fiscal year, and with it comes the possibilities of better tax planning and making the right financial moves.

The clamour that I see among some of my friends each year to find avenues to save tax is something that can easily be done away with.

In the next 5 minutes, I’ll attempt to help you understand the basic concepts of income tax, and by the end, you should probably have a better idea of planning out your taxes. Come, walk with me then.

New tax regime vs old tax regime - What has changed?

The year 2020 brought a new regime. However, before deciding on the regime to file your returns, it’s imperative to understand the difference between the two. 

The new tax regime has more slabs with lower tax rates, and almost all the usual income tax exemptions present in the existing regime (oddly now referred to as the old regime) are not applicable here. With the flexibility to choose, the regime cannot be changed for the current financial year once you’ve made a choice. So it’s always advisable to compare the two regimes using online calculators before finalising.

So, what’s the right choice here?

The right choice depends entirely on your gross annual income and the tax-saving tools you have been using. When I made this choice two years ago, I took the first step to calculating my net taxable income. I did this by taking my gross income and subtracting the standard deduction of ₹50K, other exemptions like HRA, LTA etc., the voluntary investments to avail Sec 80C deductions (LIC, PF, ELSS, NPS etc.) and the Section 80D deductions (Medical Insurance, Critical Health Insurance etc.).

Having done this, I did another round of calculations using the new tax regime slabs with no deductions permissible. If manual calculations are not your cup of tea, you can use a host of free online calculators to arrive at your decision. The bottom line is that you should have clarity on the tax liability in both scenarios. Here is a table for easy reference while making your calculations.

Income slabs (Rs)

Old Regime

New Regime

Up to ₹2.5 lakh

Nil

Nil

₹2.5-5 lakh

5%

5%

₹5-7.5 lakh

20%

10%

₹7.5-10 lakh

20%

15%

₹10-12.5 lakh

30%



20%

₹12.5-15 lakh

25%

Above ₹15 lakh

30%

In my case, specifically, I maximise my Sec 80C deductions (limit ₹1.5 Lakh). Moreover, I also claim deductions for HRA as per the permissible limit. Choosing the new tax regime will make me miss out on these, increasing my taxable income and net tax amount. So, naturally, I have stuck around with the old tax regime.

And what’s this advance tax that some are paying?

Okay, so if you have other sources of income apart from your regular salary, and your tax liability for the financial year is more than ₹10,000, you’ll have to pay something known as advance tax. Examples include rent from property, interest earned on fixed deposits or savings accounts, capital gains from selling shares of mutual funds, etc.

The calculation is fairly simple since no external factors are involved here. All you have to do is 

  1. Estimate your earnings for the year from non-salary sources, as mentioned above. 
  2. Then the combined income needs to be added to your gross salary for the year. 
  3. Now, use the income tax slabs for the old or new regime (as opted for) and calculate the tax applicable. 
  4. From this amount, you should subtract the already deducted TDS and the other income tax deductions for salaried employees (in the old regime). 

If the extra amount exceeds ₹10K, then you are required to pay advance tax. Typically, the 15th of March of each year is the deadline for 100% payment of the advance tax. If not done, there is a penalty of 1% per month till the due amount is paid.

Fortunately, the process for payment of advance is rather simple. It can be done conveniently online on the Income Tax website and help you save on avoidable late fees and penalties.

Tips on tax planning and tax-saving

The new tax regime doesn’t offer many deductions, and if I save on tax, then deductions are something I’ll need to maximise. So, in all fairness, it makes more sense for me to stick to the old regime. Under this, I can maximise the following deductions:

  • HRA - for the rent that I pay for the house
  • Section 80C deductions - up to a limit of ₹1.5L including life insurance premium, ULIP, ELSS, PF, ELSS et al.
  • Section 80CCD deductions - up to a limit of ₹50K under voluntary NPS contribution
  • Section 80D deductions - up to a limit of ₹25K for medical insurance for self and dependents. Another ₹50K in the case of senior citizens.


So, you see, tax planning is no rocket science. All it takes is careful consideration of your annual earnings and proper research into the various tax-saving tools available for you to invest. Pay special attention to your preferred investment horizon, and risk appetite. Don’t let tax-saving concerns carry you away and drive you into locking a chunk of your money for long periods, rendering you unable to fulfil your short or mid-term goals. 

FAQs

What is the basic concept of income tax?

Simply put, tax is what you pay the government as costs for running the country. It takes money to build infrastructure like roads, or pay the salaries of civil servants like the Police, the army, and so on. Income tax is a way of collecting money from citizens based on how much each person earns. The more you earn, the more you pay. There are of course ways that the government lets you avoid paying taxes if you’re putting the money into something the government can use - like investing in infrastructure bonds, or taking a loan (the interest from which will go towards maintaining financial institutions). 

What are the 4 types of income taxes?

Income tax, by definition, is something the government takes from your income. If you’re a salaried professional, you might notice the term TDS in your salary slip. This stands for Tax Deducted at Source, it means the government has already taken the tax from your salary before giving it to you.

Even if you’re not a salaried employee, you still pay income tax because you surely have some means of earning money. Here are some other types of income tax:

  1. Income tax on Salary
  2. Tax on owned property (like a house)
  3. Tax on profits earned from a business
  4. Capital gains tax - this is the tax you pay on money you may through stock trading or mutual fund gains

Which is the best option to save tax?

Depending on how much you earn and what stage of life you are in, there are different ways to save tax that could work for you. Here are some:

  • ELSS Mutual Funds - This is a class or type of mutual fund that require you lock in an amount for 3 years at a stretch. Also known as tax-saver funds, these funds give you returns of up to 20% per year. ₹1,50,000 of your income is exempt from tax every year.
  • NPS or National Pension Scheme - this is a government initiative that lets citizens invest in it at regular intervals. A maximum of ₹50,000 per year is exempt from income tax.
  • PPF or Public Provident Fund - Another government scheme that lets you save money into this fund regularly, and at the same time, be exempt from tax for up to ₹1,50,000 per year.

There are many more ways to save on tax, but here are some easy to set up and effective ways to save on tax.

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