Tax Planning - Meaning, Types and Benefits

Paying taxes is considered an essential component of being a lawful citizen. While it is important to pay taxes and contribute to your country’s economic growth, doing so without careful planning may lead to financial loss. To combat this, you may resort to strategic tax planning.

What is Tax Planning?

It may be referred to as the process of planning one’s finances in a way that there is optimum tax efficiency. Tax planning may involve making decisions related to purchasing financial products and investments with the intention to reap optimal tax benefits. These benefits may be in the form of tax deductions, exemptions and rebates as per the relevant tax slabs, and so on.

In India, the rules and regulations related to taxation are laid down in the Income Tax Act of India of 1961 (the Act) as amended from time to time. Effective tax planning may mean that you take advantage of the provisions laid down in the Act to manage your overall tax liability and outgo.

Now that you may know what tax planning is, let’s look at its benefits, types, and how you may save on taxes with tax planning.

What Are the Benefits of Tax Planning?

Some of the benefits of Tax Planning are:

1. Reduction in tax liabilities

As explained earlier, tax planning helps you in reducing your taxes by taking advantage of tax benefits provided under the Act and taking effective financial decisions. To achieve this, one may have to make investments and purchases of financial products eligible for tax deductions and exemptions, such as those listed in Section 80C of the Income Tax Act of 19611. Deductions under section 80C of the Act can only be claimed under old tax regime.

2. More savings

Less money spent on taxes may help you in planning your finances and investments. The money saved from reduced tax liability may be used to fund other investments, premium for life insurance policies, or finance a purchase you may have planned for a long time.

3. Contribution to the nation’s growth

When taxpayers plan their taxes, file their tax returns and pay taxes within time, the nation may benefit from it in the form of timely collection of tax revenue. This may help maintain a steady flow of money to the concerned authorities who may use it to fund the economic growth of the nation.

Thus, the benefits of tax planning in India may be many, not just on an individual level but also at a larger scale.

What Are the Types of Tax Planning?

You may be clear on the meaning of tax planning and its benefits; however, did you know that tax planning may be of various types? Here is a look at the four types of tax planning:

1. Short-range tax planning

This type may include taxpayers making decisions to reduce their tax liability within a short time frame. Usually, investors and taxpayers may follow the short-range tax planning strategy at the end of the financial year when they realise, they have a small amount of time to reduce their yearly tax outgo.

2. Long-range tax planning

It may refer to a manner of tax planning wherein long-term commitments may be made to save tax not just for the current fiscal year but also for the years to come. It may involve the taxpayer making periodical investments in products having a tenure of multiple years.

For instance, some individuals may buy life insurance near the end of the fiscal year to gain from its tax-saving qualities. ^[1]

3. Permissive tax planning

Out of the many types of tax planning, permissive tax planning may be considered as the one focusing more on maximising the benefits provided under the Income Tax Act of 1961, and less on increasing the taxpayer’s savings. For instance, a permissive tax-planning strategy may include making donations to charitable institutions, since it may provide tax benefits under Section 80G of the Act.²

4. Purposive tax planning

When you may carry out tax planning with a specific purpose in mind, it may be termed purposive tax planning. This may include choosing appropriate investment plans and schemes such that an optimal level of tax benefits may be achieved to meet a specific purpose.

Hopefully, you may have a clearer idea of the meaning and types of tax planning in India by now. What you may want to do next is to understand where you may start on your tax planning journey.

How to Get Started with Tax Planning in India?

An individual looking to save their taxes via tax planning may start with the following steps:

1. Assess your income

This step may not only mean taking your annual salary into consideration but also keeping your other sources of income, such as interest on deposits, returns on investments, and so on, in mind. This may help you get an idea of the tax slab you may be falling under.

2. Evaluate the taxability of your income

Understanding the taxability of your sources of income may help you optimise the benefits of tax planning. This may also help you choose the right products, since some products may help you save more taxes than others. You may also be able to identify the gaps in your present financial portfolio, which may be reducing the tax savings you can enjoy.

3. Choose products to increase your tax savings

After you may have identified the gaps, you may start trying to implement the right strategies to fill those gaps. For instance, if you feel that you could add more products to your portfolio, then you may start with the purchase of such products.

4. Note down the tax benefits you may claim

After you may have purchased the relevant products, you may want to check the tax benefit each product may provide to you. For a clearer idea of your tax liability, you may want to use an income tax calculator.

How to Save Taxes with Tax Planning?

The Income Tax Act of India, 1961, allows taxpayers to save taxes via several deductions and exemptions under its various Sections if one chooses old regime. Some Sections that may provide tax benefits to you include:

1. Section 80C ^[1]

Under Section 80C of the Act, individuals may be able to claim a collective tax deduction of up to Rs 1.5 lakhs by opting for products such as life insurance plans, certain government schemes, retirement plans, and so on.

2. Section 80D ^[3]

This Section may offer tax deductions for people paying premiums for health-related insurance policies. If you are opting for a critical illness rider with your life insurance policy, Section 80D may still be applicable.

3. Section 80G ^[2]

As mentioned previously, donations made to charitable institutions may be used to claim deductions under Section 80G of the Act.

Tax deductions and exemptions are subject to the tax regime chosen. Certain benefits may only be available under the old tax regime. Please refer to the tax laws and consult your financial advisor for more details.

The above benefits may only be a few benefits you may claim. For a more exhaustive list of tax-saving Sections and to know more about what tax planning is, you may want to consult a tax expert or a financial advisor.

Sources:

1. https://cleartax.in/s/80c-80-deductions

2. https://cleartax.in/s/donation-under-section-80g-and-80gga

3. https://cleartax.in/s/medical-insurance

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