Know the Difference between Tax Deduction and Exemption

Know the Difference between Tax Deduction and Exemption

Every industry comes with its technicalities, and the income tax institution also has its own set of jargon. Some expressions may have more than one implication considering its usage, while some phrases may have analogous significances but diverse applications. For instance, the difference between exemption and deduction is not clear to all, even though both are useful in minimising the amount of taxable income. However, the difference between exemption and deduction in income tax are applied to different fields of your taxes.

If you are earning an income, then sooner or later, you are bound to hear the words ‘Income tax’. However, there is a difference between exemption and deduction. The quantum of tax you may have to pay every fiscal year is usually based on how much you earn, your tax-filing status and so on. Luckily, the Income Tax Act has offered various provisions that allow you to reduce the amount you pay as tax. But before you take advantage of your tax benefits, you need to understand the jargons thoroughly.

For example, take the two terms: Tax deduction and tax exemption. A lot of people can be confused between exemption vs deduction and may use the two words interchangeably. However, the differences between exemption and deduction are plenty. So, let’s find out the main differences between tax deduction vs tax exemption.

Tax deduction

Tax deduction refers to the amount of money that is reduced from your total taxable income. The final tax payable is calculated depending on the balance ‘taxable income’. Tax deductions aim to promote the culture of savings and investments among the general public.

However, it is good to know that tax deduction is only allowed on specific investments or expenses incurred by the taxpayer. This includes medical fees, transportation charges, donations made to charities, investments made in specific avenues such as Equity Linked Saving Scheme funds (ELSS), Public Provident Fund (PPF) and National Pension Scheme (NPS).

The Income Tax Act sections between 80C and 80U deal with all the deductions available to taxpayers.

Tax Exemption

In the world of taxation, the word ‘exemption’ means exclusion. So, if a particular income is exempt from tax, it will not be included in the total revenue for tax purposes. This reduces the total taxable income of a taxpayer. All exemptions are dealt with under Section 10 of the Income Tax Act.

While certain incomes such as agricultural income are completely exempt from taxation, there are other incomes that are partially exempted from tax. This means only the portion of income that exceeds the exemption is subject to tax. This includes:

a) House Rent Allowance (HRA)
b) Leave Travel Allowance (LTA)
c) Entertainment Allowance
d) Special allowances to meet personal expenses
e) Long-term capital gains on equity funds

Tax deduction vs tax exemption

Tax exemption applies to all taxpayers in the country. For instance, the amount paid to a salaried employee as HRA is not taxable. However, tax deduction applies only to those who qualify for the specific criteria. For instance, Section 80D of the Income Tax Act can be used to claim deductions on premiums paid for medical insurance policies.

Even though Income Tax is a mandatory responsibility to be paid by every citizen, based on his or her paying capacity, age, and gender, taxpayers can obtain relief through the various provisions to reduce their overall tax financial obligation.

Understanding the difference between exemption and deduction in income tax can help in making smarter decisions before the annual tax planning process commences.

Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.


Tax saving schemes with a purpose

Who does not want to save Rs 60,000 in taxes? That’s why everyone in the know makes a beeline for the various tax-saving investments that avail you a tax deduction of Rs 2 lakh. But they often make the mistake of buying tax saving schemes without much thought to other factors. After all, there is more meaning to them than just tax-saving. Income tax saving options are investments meant to earn returns and help you fulfil different dreams in life. The numbers can prove this to you. Have a look:Tax saving with a purposeLet’s say you invest Rs 1.5 lakh, your mandatory 80C tax-saving investments, on a monthly basis throughout the year. You then end up investing Rs 12,500 every month the whole year. Now, thanks to the power of compounding, this amount earns you returns every month. And with time, even the returns compound to expand your wealth. Pretty soon, the wealth your investment generates would dwarf the Rs 45,000 you saved in tax.Now this happens in two key phases. 1) Accumulation Phase: This is the pre-retirement phase wherein you invest Rs 12,500 per month for the entire earning period till the age of 60. This is how your investments grow over a span of 35 years (assuming you being at the age of 25) 2) Retirement Phase: Then comes the post-retirement period when you let the investments grow without redeeming the entire amount. You may not need any further contribution in this phase. All you need to do is redeem your investments partly--as and when needed for your regular monthly expenses. This way, your investments grow continuously for years together. In such a case, after another 20 years, your portfolio can grow further as below: Similarly, other goals can be fulfilled too. To fulfil major goals and associated expenses, you can simply withdraw from the investment corpus as and when needed. And if you choose the right tax-saving investment option, such redemptions have zero tax implications too.  This applies to all kinds of goals, whether they are time-bound or not. For example:Child Higher Education: If your child needs say Rs 20 lakh by the time you turn 45 years of age (20 years after you first started investing), then all you need to do is redeem that amount while also continuing the investments. The entire focus of this plan is to continue the investments without a break! Alternately, you could choose an investment that gives you an annual payout like a Money-back insurance plan. You time the investment such that the payouts synchronise with your child’s fee payments, etc.Secondary source of income: Almost all the tax-saving investment options you have offer some kind of regular payment. This could be in the form of interest payments or dividend distributions. Over a period of time, when your corpus grows large, even a minuscule interest or dividend payout can amount to large sums. These can be tax-efficient modes of getting a secondary income. You can use these to fulfil other dreams like travelling, etc. The bottom lineConsider additional tax saving options other than 80c. Your tax saving investments options, if planned properly, can turn out to be a sweet spot in your investment portfolio. But remember, these investments need to be planned and chosen with great care. Only then can they help meet your long-term financial goals. At IndiaNivesh, the wealth management team can help you make such wise tax-saving decisions that also fulfil various life goals. Click here to know more.What next?We’ve spoken so much about tax planning and tax saving, what they are and how they benefit you. But let’s move to the key information—how to plan your taxes.DisclaimerInvestment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.

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How to plan taxes?

India has one of the highest tax liabilities in the world. This means that a large amount of your income is taxed. What is tax planning meaning? To plan your taxes mean to analyse your financial situation and build a strategy from a tax perspective towards the objectives of tax planning. However, there are ways to reduce your taxes if you plan efficiently. The Income Tax Act recognises various tax-saving instruments and avenues which can help reduce your tax outgo. So, why not plan to ensure your hard-earned money is not taxed, especially when there are ways to reduce it? Tax planning and management can be done easily if you know how. Here are some methods of tax planning that can help you do it: Basic steps to plan taxes 1. Understand your gross annual income The first step includes understanding your total income from all sources. If you are employed, it would be your annual salary. If you are an entrepreneur, your business or professional income would be the major source of your income. Also include other sources like income from house property, capital gains, income from other sources, etc. 2. Reduce your taxable incomeIf you are an employee, you can restructure your salary to optimise tax-saving through the different types of tax planning. There are some components in your salary structure which can be used to lower your taxable income. They are: a. House Rent Allowance (HRA)b. Leave Travel Allowance (LTA)c. Medical reimbursementd. Meal allowance, etc. Claiming these allowances will result in you paying lesser tax. 3. Use tax-saving investments There are various tax-saving investments under Section 80C of the Income Tax Act. Investing in these funds can get you tax exemption up to Rs 1.5 lakh. Some of the funds are: • Public Provident Fund (PPF)• Life insurance• Equity-linked savings scheme (ELSS)• Fixed deposits• National Savings Certificate (NSC) Also, you get an additional exemption of Rs 50,000 if you:• Invest in National Pension Scheme (NPS)• Have a home loan. Your tax is exempted if you are repaying the principal and interest components of the loan. Furthermore, your saving account interest can be claimed as an exemption up to Rs 10,000. So, explore all possible investment options and reduce your taxable income. 4. Take help of family members to save taxIf you are living in a property owned by your parents, give them rent and claim the HRA. If you don’t have an HRA component, you can still claim exemption on the rent paid under Section 80GG of the Income Tax Act. You can invest in a tax-free instrument in your spouse’s name. This can earn you tax-free income. Pay health insurance premiums for your family and parents. If all your family members are below the age of 60, you can earn a tax exemption of Rs 50,000. If your family is below is 60 but your parents are above that age, the maximum tax exemption is Rs 55,000. If all of them are above 60, the tax exemption ceiling is Rs 60,000. 5. Keep tax proofs handy for verificationThe taxman can ask for last 7 years’ documents. 6. File your taxes before deadlineDoing so will help you get a quick refund if your tax liability is below the tax you have already paid. The smaller details you shouldn’t forget 1. School tuition fees of first two children are eligible for tax deduction under Section 80C2. Mandatory contribution towards your Employees Provident Fund is also a part of Section 80C investments3. Plan your taxes with reference to your goals and tax bracket. If you are in a higher tax bracket, choose investments which will give you maximum tax relief. For instance, if you are in the 30% tax bracket, investing in equity can help you save tax if you plan to sell them within 12 months. That’s because there’s a flat 15% short-term capital gains (STCG) tax on selling your equity within 12 months. Thus, this can be a better idea because you end up getting taxed 15% and not 30%. Smart tips for tax-saving investments 1. Opt for a monthly investment like an SIP in ELSS or a monthly contribution towards PPF2. Avoid fixed multi-year or long-term commitments if your income is not stable3. Complete your KYC with a fixed e-mail ID and phone number for online transactions4. E-verify your tax online using your Aadhar number and bank account. To sum up Taxes can eat into your annual income. So, take these steps to ensure you don’t pay more than what’s required. There is a need of tax planning and an effective plan will ensure you invest to maximise your wealth and save taxes. This is where IndiaNivesh’s services can be critical. At IndiaNivesh, you can get the following advantages:• Expertise in tax-planning and investment ideas• Scientific and well-researched process of product selection• Suitability of products that match your risk and investment profile so that they can fulfil your goalsDisclaimerInvestment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.

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