Understand the legal ways to reduce taxable income in India.

Introduction

Every year we have to pay a sizable amount of our income to the government, whether it was received from our employers, earned from the business or in any other way. We all want to reduce this amount by choosing any way to avoid tax. But knowing how to avoid income tax or tax evasion is not a good idea. But rather, you should focus on tax planning or tax avoidance, which are the legal ways to reduce income tax.

In this article, you will learn about:

• Income Tax Act, 1961
• Section 80C and Instruments

1. Public Provident Fund (PPF)
2. National Saving Certificate (NSC)
3. Tax-saving FDs
4. Senior Citizen Saving Scheme (SCSS)
5. Sukanya Samriddhi Yojana
6. Equity Linked Saving Schemes (ELSS)
7. New Pension Scheme (NPS) 
8. Unit Linked Insurance Plan (ULIPs) 
9. Home Loan Principal Payment
10. Tuition fees

• Other Sections and Deductions

1. Medical Insurance Premium
2. Interest Paid on Education Loan
3. Interest Paid on Home Loan
4. Donation to Charitable Institutions
5. House Rent
6. Interest Income
7. Money spent on a Dependent 
8. Medical Expenses
9. Money spent by Disabled Individuals
10. Donation to Political Parties

• Suggestions on how to choose from various options

Income Tax Act, 1961

The Income Tax Act, 1961 was introduced by the Government of India to levy, collect and impose rules related to income taxes. All the sources of income from which you can profit and earn money are taxable, which can be a total of income from salary, income from house property, income from profits and gains of a profession or business, income from capital gains and income from other sources.

Then, you might be thinking about how to reduce income tax liabilities every year. The act then provides a solution for that by providing some instruments and spending activities in which you can invest under Section 80C to reduce the taxable income. There are other sections as well that provide tax deductions on various expenses and income amounts you made each year.

You can choose between the two tax regimes in India. If you choose the old tax regimes, then you have to separately apply for deductions in the sections mentioned, but if you choose the new tax regime, it does not provide the deductions and thereby lowers the tax rates charged. Both options are appropriate.

Section 80C and Instruments

The best and legal way of income tax reduction strategies are provided under the Section 80C which allows you to reduce your income tax liabilities by ₹1.5 lakhs in a financial year under the schemes and investments mentioned in the Income Tax Act. But remember that all these schemes give a total of deduction of up to ₹1.5 lakhs.

Public Provident Fund (PPF)

The Public Provident Fund (PPF) is an investment option to reduce income tax for a long period of time—a minimum of 15 years with an extendable period of 5 years. The minimum amount required to invest in PPF is ₹500, which can be paid in lump sum or monthly installments. The current interest rate is 7.1% per annum. If you invest more than ₹1.5 lakh in a year, you are not entitled to earn interest on the extra amount. The amount you earn as interest and the amount you get on maturity are tax-free.

National Saving Certificate (NSC)

The National Savings Certificate is a low-risk, fixed-income investment option offered by the government. The maturity period is 5 years and the current interest rate offered is 7.9% per annum. You can invest as little as ₹ 1,000 (or in multiples of ₹100) as an initial investment.

Tax-saving FDs

These FDs are one of the traditional ways to reduce taxable income in India, where you can invest a lump sum with any bank and earn interest on that amount. The banks decide the interest rates, which can start at 6%. The maturity period is 5 years, with an additional 5 years extended period.

Senior Citizen Saving Scheme (SCSS)

A Senior Citizens’ Savings Scheme (SCSS) is a scheme provided by the Government of India that is a retirement benefit programme for an individual who is already retired or who is taking a voluntary retirement. As you reduce your income in retirement, this scheme provides regular income in the form of returns which is tax-free up to the amount ₹10,000 per year. The maturity period is 5 years, with an extendable period of 3 years. A SCSS account can be opened at a post office or a bank by depositing a minimum of 1,000 and a maximum of 15 lakhs in a single installment.

Sukanya Samriddhi Yojana

This scheme was started by the government under the Beti Bachao, Beti Padhao campaign. The parents or guardians can open this account of their girl child of age of 10 years. You can earn a yearly interest of 7.6% and the maturity period is 21 years or upon her marriage after attaining 18 years. The minimum deposit amount for an SSY account is ₹250. The investment amount and withdrawals of 50% deposits and the maturity amount are all tax-free.

Equity Linked Saving Schemes (ELSS)

Equity Linked Saving Schemes or ELSS is the only option available in the mutual fund category to reduce tax on your yearly income. These mutual funds have a lock-in period of three years and invest 65% of their assets in equity and equity-related securities. Therefore, they provide higher returns as compared to any other scheme available under Section 80C. Like any other mutual fund, you can also invest in ELSS mutual funds using small monthly installments through a SIP (Systematic Investment Plan) or paying a one-time amount called a lump sum amount. You can save up to ₹46,800 in taxes by investing a total deductible amount of ₹1.5 lakh in a financial year. The earnings you get from investing in these mutual funds are taxable at the long-term capital gains (LTCG) rate of 10% if they are more than ₹1 lakh.

New Pension Scheme (NPS)

The National Pension Scheme or NPS is a pension saving scheme for individuals to earn a regular pension after their retirement. This scheme is best suited to individuals working in the private sector or salaried employees aged 18 to 70. This scheme provides tax benefits under Section 80C and Section 80CCD. With a 75% equity investment, the interest rate earned ranges between 9% and 12%. The maximum deduction one can claim under 80CCD(1) is 10% of the salary and for the self-employed taxpayer, this limit is 20% of the gross income. Section 80CCD (1B) provides additional deductions of ₹50,000 on investments in NPS, thereby the total amount is ₹2 lakhs. 

Unit Linked Insurance Plan (ULIPs)

Unit-Linked Investment Plans are a combination of two plans where some portion is in life insurance and the remaining amount is invested in stocks which helps in reducing taxable income. You can buy these plans for yourself, your spouse or your child. The interest rate typically ranges between 12% and 14% and there is no limit on investing the amount. The maturity amount, interest earned and investments are all tax-free up to a limit of ₹2.5 lakhs per year. Other insurance policies, including term life insurance policies and endowment policies, are also tax deductible. However, the insurance coverage must be at least 10 times the annual premium.

Home Loan Principal Payment

You must be thinking of how to save tax on the amount you paid on home loans. You can deduct the principal amount up to ₹1.5 lakh per year under Section 80C, but interest is not included.

Tuition fees

Tuition fees of your child’s education is also important to know how to save income tax in India. You can claim up to ₹1.5 lakhs in tuition fees for two children who attend full-time school, college or university. 

Other Sections and Deductions

Medical Insurance Premium

You must be wondering how to reduce taxable income more than ₹1.5 lakhs as mentioned in the earlier section. Then, Section 80D helps you by providing an additional deduction of up to ₹50,000 (or ₹1 lakh in some cases) on the amount you may pay as a premium for medical insurance for yourself, your spouse, your children or your parents.

• If you have purchased medical or health insurance for yourself, your spouse, your children and your parents (below the age of 60), then you can claim a maximum tax deduction of 50,000 on the premium paid in a financial year. 
   
• If you have purchased medical or health insurance for yourself and your parents (all are above the age of 60), then you can claim a maximum tax deduction of 1 lakh on the premium paid in a financial year. 

Interest Paid on Education Loan

The interest you are paying on the education loan of yourself, your child, your spouse or a person for whom you act as a guardian can also help in knowing how to reduce tax on income. The loan taken from the bank or FI helps you get a deduction on the amount of the interest paid on an education loan with no maximum limit. The maximum duration for which you can claim the deduction on the interest amount paid is 8 years or the expiration of the loan, whichever is less.

Interest Paid on Home Loan

If you are purchasing a home for the first time, you can claim the deduction on the amount you paid as interest on the loan in your yearly total income under Section 80EE up to the amount of ₹50,000. This deduction is in addition to the ₹1.5 lakh under Section 80C and ₹2 lakh limit allowed under Section 24 of the Income Tax Act. The market value of the home for which you have taken the loan must be less than or equal to ₹50 lakh, with a maximum loan amount of ₹35 lakh taken between April 1, 2016 and March 31, 2017. A new Section 80 EEA provides the first-time home buyer who has taken a loan between April 1, 2019 and March 31, 2022, with a deduction up to the interest amount of ₹1,50,000.

Donation to Charitable Institutions

You are excited to know how to save income tax on the donation you are paying under Section 80G to any charitable institutions registered under Section 12A. This deduction is not applicable if you have selected the new tax regime. There are various types of donations for which you can receive tax breaks ranging from 100% to 50%. Cash donations will help you to deduct tax to an amount up to ₹2,000. Cash, cheque, draft or any other mode of donation will help you get the deduction on more than the ₹2,000 donation amount.

House Rent

If you are not getting the HRA (House Rent Allowance) component on your salary or a self-employed living on a rent, then you can claim a tax deduction on the taxable income you paid as the rent amount under Section 80GG. The maximum amount you can claim as a deduction on your taxable income depending on the total rent paid is ₹60,000 annually (₹5,000 monthly) or 25% of the total annual income (annual salary) or total rent paid minus 10% of the total income, whichever is less.

Interest Income

The interest you earn up to the amount of ₹10,000 on the savings account of a bank, co-operative society or post office helps you get the tax deductions under Section 80TTA.

Money spent on a Dependent

The expenses are incurred on the treatment, nursing, rehabilitation and training of the differently-abled dependent specified under section 2(i) of the Persons with Disabilities Act, 1995., who can be a child, sibling, spouse or other family member of an individual The deduction amount is dependent on the percentage of disability. A deduction of up to ₹75,000 is allowed if the disability is more than 40% but less than 80%. If the disability is more than 80%, you can claim a deduction of ₹1,25,000. 

Medical Expenses

Medical expenses paid on behalf of a family member, spouse, parents, siblings or any other dependent for treatment of the diseases listed in Section 80DDB are tax deductible equal to the total amount paid for the treatment or up to ₹40,000, depending on which is lower. For senior and super-senior citizens, a deduction of ₹1,00,000 or the actual amount paid for the treatment can qualify as a deduction, whichever is less.

Money spent by Disabled Individuals

Money spent by disabled individuals on their own expenses for the diseases listed in Section 80U are allowed for the tax deduction. A deduction of ₹75,000 is allowed for people with disabilities of at least 40% and a ₹1,25,000 deduction for people with severe disabilities of more than 80%.

Donation to Political Parties

To know how to reduce taxable income in India by donating to political parties, individuals can claim the total deduction on the donation amount under Section 80GGC made to the political parties, which have to be registered under Section 29A of the Representation of the People Act, 1951. You can donate up to 10% of your gross earnings every year to any political party.

Suggestions on how to choose from various options

After reading so many options and sections, you might be confused about how to choose from different options and how to reduce tax liabilities every year. So, here are some suggestions based on your risk-taking capacity.

1. High risk

If you are an individual who wants to save on your taxable income but also wants to earn a high return on the instruments used to do so, you can choose to invest in the ELSS (Equity Linked Saving Schemes) mentioned under Section 80C. This is the best option because they have the shortest lock-in period as compared to any other instruments under Section 80C and have the potential to offer the highest market returns.

       2. Average Risk

If you have an average risk taking capacity, then you can invest some of your money in PPF or tax-saving FDs to reduce risk and the rest in ELSS to maximize returns.

       3. Low Risk

If you aren't ready to take any amount of risk, then you can simply invest your money in government-backed instruments that provide assured returns, such as the Public Provident Fund (PPF), National Savings Certificate (NSC), tax-saving FDs, Senior Citizen Savings Scheme (SCSS) or Sukanya Samriddhi Yojana. But these options provide you with a lower return that doesn't also beat inflation in the future.
 

The total amount of tax deduction you can get in the financial year is ₹78,000. Let’s see the breakdown on how you can get this.
 

Conclusion

Knowing how to reduce taxes on your yearly income is very important because there are so many other sections besides Section 80C that help you reduce your liabilities. But you have to cautiously decide on how to invest in all these instruments based on your risk appetite, liquidity needs and expected returns.