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Tax Planning for Salaried Individuals
January 31 , 2013

Tax planning is easiest for salaried persons – much easier than for self employed or businessmen. However, it is precisely the salaried class that often neglects to do elementary tax planning, and ends up parting with unnecessary hard earned money.

Too much of the market focuses on tax saving investments, since that's where the brokers make money. However, there are actually three big chunks of savings you can have on the tax front, if only you take a bit of time to read and implement the suggestions given here:

1. Restructuring the salary itself can give huge tax benefits. Most employers work on the Cost-to-Company (CTC) basis, wherein flexibility within the boundaries of the CTC is permitted. You can discuss this with your HR / Finance departments

a. Consider the House Rent Allowance (HRA) component of your salary - If you live in your own house, it is better that you minimize the HRA and increase the Basic component of your pay. This has advantages in terms of getting you a better Provident Fund and Gratuity benefits. If you pay rent, adjust your HRA to be close to (Rent paid – 10% * Basic Salary)*1

b. Ensure that your salary slip has a conveyance allowance of Rs 800 per month, and a medical allowance of Rs 1250 per month. These are tax deductible allowances you get. The conveyance allowance is available irrespective of bills, while you need medical bills to avail the medical allowance.

2. The second big bucket of tax savings is the deductions

a. There is a long list of tax saving investments, but we recommend the following simple set

  1. Look at what your PF deduction for the year is
  2. If it falls short of Rs1 lakh, invest the difference in Equity Linked Savings Schemes, which are mutual funds with a 3-year lock in*2
  3. Invest Rs 20,000 in infrastructure bonds. 

Get a medical cover for yourself and your family, including dependent parents. Usually the full amount of premium paid would be tax deductible*3

b. If you have a home loan or education loan going, your Bank will usually give you an interest certificate. Nothing more is needed to get this tax benefit.

3. The most neglected aspect of tax savings is tax on investment returns. Remembering some simple thumb rules can ensure your investment returns are tax efficient:

a)    Equity (listed shares or mutual funds) is more tax efficient than debt or real estate

b)    Avoid redemption with one year as far as possible, since long term capital gains tax rates are lower than short term ones

c)    Avoid churning your investments too often. You pay capital gains tax every time you churn

d)    If you fall in the higher tax bracket, avoid interest income (such as fixed deposits) and opt capital gains income (such as debt mutual funds). Capital gains are more tax efficient than interest income.

That's it! Your tax planning is done! However, make sure your paperwork matches your planning initiatives, so that these tax benefits actually accrue to you:

  • Give your employer timely declarations and supporting documents on your tax saving investments and loans discussed above. They will then compute your tax appropriately and avoid deducting an excess. Getting back excess tax deducted can be extremely painful and time consuming.
  • You will get Form 16 from your employer at the end of the Year. Run a rough check to ensure the above three buckets of benefits have come to you as per your plan.
  • Make sure you file tax returns in time. 31 July of every year is usually the deadline for filing returns for the Financial Year ending 31 March of that year.

*Notes:

1. Your HRA tax benefit is Minimum of (50% * Basic, Rent paid - 10% * Basic, HRA). The closer these three numbers are to each other, the better it is for you.

2. There are several other tax saving options including PPF and Unit Linked Insurance Plans. But we recommend ELSS for their simplicity, lower lock-in and customer friendliness.

3. The maximum insurance premium that qualifies for tax deduction is Rs 15,000 for you and Rs 20,000 for aged dependent parents. But you would find that most well-chosen medical insurance policies have lower premium than this.

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