The importance of tax planning
Mankind has been paying taxes for hundreds of centuries. In fact, a quick Google search will tell you that the first known instance of taxation took place in Ancient Egypt around 3000 – 2800 BC. Since then, taxation as a policy has endured and has become almost ubiquitous. Today, most countries across the world levy both direct and indirect taxes as a means to provide for the public and common needs of the country’s population. Interestingly, direct taxation or tax on your income is often viewed as a burden with most people looking for some kind of relief in direct taxation. This perspective stems from the fact that direct tax reduces your overall income and can thus have an impact on your financial journey.
Tax planning is essential
The good part is that the burden of tax on your income can easily be reduced through astute tax planning. The main advantage of tax planning is that it can help you reduce your overall direct tax outgo, thereby ensuring that your net income increases. The government has mandated several ways by which you can save taxes and reduce your taxable income. As per the Income Tax Act, 1961, there are various investments and payments that you can make and claim as a deduction to reduce your taxable income and thus the tax outgo.
Inarguably, the main benefit of tax planning is to reduce tax and increase income in hand. However, tax planning also has an added advantage. Under chapter vi A of the Income Tax Act, 1961, investments in certain instruments can be claimed as a tax deduction with an annual limit of Rs. 1,50,000. For example, you could invest in an Equity Linked Savings Scheme (ELSS) mutual fund or contribute to the Public Provident Fund (PPF) and claim the amount paid as a tax deduction. These are just two examples. There are several other investment options that are available under chapter vi A. By doing so, you can also explore the potential of generating income.
Thus, astute tax planning has two primary benefits. One, it helps you reduce your tax outgo and two, it can help you reap the benefits of investing through potential future gains. However, you must not leave tax planning until the end of the financial year. As it is said, ‘a stitch in time saves nine’. Thus, tax planning in advance can save you from unnecessary stress in the last quarter of the financial year.
Let’s understand the importance of tax planning with a simple example.
On 2nd January 2022, Arun came into office in a cheerful mood. Things were looking up, he had spent the last week of 2021 with his family, and now he was looking forward to his annual appraisal. However, an email from HR shed gloom over his day. You see, he had just received an email from HR requesting for investment declaration proof. At the beginning of the year, he had claimed a tax deduction of INR 1,50,000, the benefit of which he had enjoyed through the year. However, he had actually not bothered making the necessary investment and now was finding it difficult to submit the necessary proofs. Unfortunately, he was only able to make investments worth Rs. 1,00,000 and had to actually pay back the balance deduction of Rs. 50,000. This resulted in a double whammy. Firstly, his income in hand reduced since a larger proportion of tax got deducted to adjust for the deduction that he had claimed at the beginning of the year but for which he could not provide any proof. And, secondly, he had to suddenly make an unplanned and lumpsum investment of Rs. 1,00,000. Since this was unplanned, it put his financial plan off track. It turned out to be a lose-lose situation for Arun. Interestingly, he could have easily avoided this situation if he had simply done his tax planning at the beginning of the financial year and in an astute manner.
You can avoid being in the same situation as Arun by planning for your taxes in advance. Inarguably, tax planning is important if you want to reduce your overall tax burden. However, with the many tax savings schemes available, it is also important for you to choose the right investments for tax savings.
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