There are various kinds of income tax deductions that can be used to reduce the taxable income in India. There are 19 ways in which tax deductions can be availed, ranging from public provident funds to life insurance and loans.
What is Tax deductions?
Tax deduction refers to claims made to reduce your taxable income, arising from various investments and expenses incurred by a taxpayer. Thus, income tax deduction reduces your overall tax liability. It is a kind of tax benefit which helps you save tax. However, the amount of tax you can save depends on the type of tax benefit you claim.
Tax Exemption vs Tax Deduction
Both the terms ‘tax deduction’ and ‘tax exemption‘ refer to a lowering of taxable income; they are forms of tax relief or tax breaks provided by the government. However, tax exemptions may also include complete relief from taxes, reduced rates and tax on only a portion of income. Tax exemption means you don’t have to pay tax for a particular income. E.g. you may get a tax exemption for donating to charitable institutions and various relief funds.
In order to encourage investments, the government generally offers tax exempt entities to invest in. Such entities are exempted from a single or multiple taxation laws. For example, investments in the Sukanya Samriddhi Scheme are fully tax exempt. Money deposited under this scheme will be exempted from tax at the time of investment, accumulation of interest and payout of returns (EEE).
In case of tax deduction, your income tax liabilities decrease by a specified amount for spending money in particular avenues. You invest in various schemes to reduce your taxable income. For example, you can get tax deduction by paying life insurance premiums and home loan EMI. Tax deductions are offered by government to tempt taxpayers to participate in programs carrying societal benefits.
What is Tax Deducted at Source?
To collect tax efficiently and quickly, the Income Tax department of the Government of India has introduced a system called TDS (tax deducted at source). Using TDS, tax can be deducted/collected at source of income. TDS is an indirect method of collecting tax by the government. It ensures a regular source of revenue for the government by ensuring the tax is collected as income is earned and not when a taxpayer files returns at the end of the year.
Any authorized person/institution on whom the responsibility of collecting tax is entrusted collects tax and pays it to the government on behalf of an individual payer. In return, the individual taxpayer gets a TDS certificate stating that the tax has been paid on his/her behalf. Thus, tax is deducted at source and is forwarded to the government on behalf of the payer. This provision of deduction of tax at source is applicable to several payments such as salary, commission, interest on fixed deposits, brokerage, professional fees, contract payments, and royalty etc.
Benefits of Tax Deductions
There are a number of benefits associated with tax deduction which include:
- Tax deductions help you reduce an amount from your taxable income and save tax. When you claim an income tax deduction, it reduces the amount of your income that is subject to tax.
- Reduced taxable income helps you save and invest money in other areas.
- Tax deduction first reduces the income subject to the highest tax brackets. So, you can claim deduction for the amounts spent in tuition fees, medical expenses, and charitable contributions.
Income Tax Return is mandatory and you cannot completely avoid paying tax. But with proper planning, you can reduce your taxable income.
Various Types of Tax Deductions in India
You can reduce your taxable income by increasing your deductions. There are many investment options and forms of expenditure which can help you get reductions on your taxable income. The Indian Income Tax Act provides many provisions for this. Mentioned below are a number of different tax deduction options.
Public Provident Fund (PPF)
By contributing to your PPF account, you can get tax deduction under Section 80C, the Indian Income Tax Act, 1961.
Life Insurance Premiums
You can get income tax deduction for paying premium towards life insurance policies for self, spouse and child under section 80C of the Indian Income Tax Act, 1961. The amount received on maturity of the policy is free from tax. However, it is subject to the terms and conditions mentioned in your policy.
National Saving Certificate (NSC)
The amount invested in NSC is eligible for tax deduction under section 80C of the Indian Income Tax Act, 1961. National Saving Certificates is one of the highly secured modes of investments in India. But, the interest earned from NSC is taxable. As an NSC is a cumulative scheme, interest is reinvested and qualifies for tax deduction.
Bank Fixed Deposits (FDs)
You can get tax deduction by investing in fixed deposits for a tenure of 5 years, under section 80C of the Indian Income Tax Act, 1961. Many banks in India offer tax saving fixed deposits. However, the interest accrued on FDs is subject to tax
Senior Citizen Savings Scheme (SCSS)
Senior citizens can get tax deduction by investing in Senior Citizen Savings Scheme offered by banks. These schemes are eligible for tax deduction under Section 80C of the same act. The interest earned from these schemes is entirely taxable.
Post Office Time Deposit (POTD)
Investing in a five-year POTD, you can get tax deduction under Section 80C. However, interest accrued on the same is fully taxable.
Unit-linked Insurance Plans (ULIP)
Investing in ULIPs for yourself, spouse and your children, you can get tax deductions under Section 80C.
Home Loan EMIs
Equated monthly installments paid to repay the principal amount of your home loan are eligible for income tax deductions under section 80C of the same act.
Mutual Funds & ELSS
Investing in mutual funds and equity-linked savings scheme, you are eligible for tax deductions under section 80C, the Indian Income Tax Act, 1961.
Stamp Duty and Registration Charges for a Home
Stamp duty and registration fee paid for transferring property are entitled for income tax deduction under section 80C, the Indian Income Tax Act, 1961.
Retirement Savings Plan
You can also get income tax deductions by investing in retirement plans offered by LIC or other insurance providers. Contribution to the National Pension Scheme is also eligible for tax deduction.
Tuition fee paid for your children’s education qualifies for income tax deduction under section 80C. However, the fee needs to be paid for full-time education in an Indian university, college and school for any two children. Tuition fee does not include any donations or development fee towards education institutions.
Medical Insurance Premiums
Health insurance premium paid for self, spouse and children qualifies for income tax deduction under section 80D of the Indian income Tax Act, 1961. The deduction allowed under this section is Rs. 25,000 for youngsters and Rs. 30,000 for senior citizens.
Investing in infrastructure bonds, you become eligible for income tax deductions under section 80CCF of the Indian Income Tax Act.
Donating for charitable tasks will help you reduce your taxable income under section 80G of the Indian Income Tax Act, 1961. However, make sure that you declare the whole contribution before 31st December each year.
Treatment of Disabled Dependents
Under section 80DD of the Indian Income Tax Act, 1961, you can get income tax deductions for medical expense incurred in the treatment of any disabled dependent of yours.
Deduction for Preventive Health Check-ups
An amount of Rs.5000 spent for preventive health check-ups of an individual or his/her family members qualifies for tax deduction under section 80D of the Indian Income Tax Act, 1961.
Interest Paid on Education Loan
You can get tax deduction on the interest paid for an educational loan under section 80E of the Indian Income Tax Act, 1961. The loan can be taken to pursue higher education by the employee, or for his/her spouse, children or a student to whom the employee is a legal guardian.
Deduction on House Rent Paid
An employee can get income tax deduction for the house rent paid, if the employee or his/her spouse does not own residential accommodation at the place of employment. This deduction is usually applicable for salaried taxpayers under section 80GG of the Indian Income Tax Act, 1961.
Your monthly basic salary is Rs 20,000. Your monthly house rent is Rs 5,000 for a flat in Bangalore. Your actual HRA is Rs 8,000, and you are eligible for 40 % of the basic pay for HRA exemption. Now,
- Actual HRA received is Rs 8,000.
- 40% of basic salary is Rs 8,000.
- Rent Paid in excess of 10% of salary is (5000-2000) 3000.
- Hence, Rs.3,000 will be the tax exemption amount for HRA paid.