For middle-class salaried employees, tax planning can significantly improve post-tax earnings and long-term wealth. Although salaried individuals have fewer avenues to reduce taxable income compared to self-employed professionals, there are still strategic ways to optimize taxes. Here’s a structured approach to maximize savings:
The most common deductions used by salaried employees include Section 80C and Section 80D deductions. Here’s how these can work for you:
80C Deductions: This is one of the most utilized sections for tax savings, allowing up to ₹1.5 lakh deduction each year. Contributions toward Employee Provident Fund (EPF), Public Provident Fund (PPF), tuition fees for children, principal repayment on a home loan, Equity-Linked Savings Scheme (ELSS), National Savings Certificate (NSC), tax-saving fixed deposits, and life insurance premiums all qualify under Section 80C.
80D Deductions: You can claim deductions on premiums paid for health insurance policies under Section 80D. This includes not only your own health insurance but also premiums for your parents’ health insurance, with higher limits for policies covering senior citizens.
While 80C and 80D deductions are commonly claimed, another significant deduction often overlooked by salaried employees is the National Pension System (NPS). Contributions made under NPS qualify for deductions under both the old and new tax regimes, offering an additional deduction on top of 80C and 80D limits. As of FY 2024-25, the NPS deduction limit in the new tax regime has been raised to 14% of your basic salary (compared to 10% under the old regime).
Section 24 Deduction for Home Loan Interest: For employees with a home loan, Section 24 allows a deduction of up to ₹2 lakh on the interest paid on the loan. This can significantly reduce taxable income for those with home loans.
Salary Structuring: Proper salary structuring can help boost tax efficiency. Increasing the basic pay, for instance, can increase the tax-free component of contributions made by your employer toward Provident Fund and NPS. In the new tax regime, employer contributions up to 14% of basic pay in NPS are tax-free, subject to an annual limit of ₹7.5 lakh when combined with EPF and superannuation fund contributions.
However, it’s worth noting that if your CTC is above ₹60-70 lakh, higher basic pay may not be the optimal strategy due to additional tax implications. Additionally, higher basic pay leads to increased gratuity and leave encashment benefits at retirement or job switch.
If your employer currently caps their EPF contribution at ₹1,800, you might consider negotiating for a 12% contribution of your basic salary instead, provided this aligns with your overall CTC.
In the old tax regime, House Rent Allowance (HRA) and Leave Travel Allowance (LTA) are also key components that can help reduce tax liability.
Strategically deferring taxes or capitalizing on tax arbitrage can boost long-term wealth. Here’s how:
Investment Taxes: Taxes on investment returns can be deferred in some cases, impacting the overall growth of your savings. For instance, while interest from fixed deposits is taxed yearly, you can defer taxes by investing in debt mutual funds, as the tax is applied only when you sell the units.
Stock Investment vs. Mutual Funds: Actively trading in stocks can lead to frequent tax events, as each transaction incurs capital gains tax. However, investing in mutual funds allows the fund manager to make changes within the fund without tax implications for you. Tax is only levied when you sell your mutual fund units.
Dividend Taxation: Dividends from stocks are taxable when received directly. In contrast, dividends within a mutual fund structure are exempt from tax, benefiting the compounding effect of your investments.
Arbitrage Funds for Short-Term Needs: When parking funds short-term, arbitrage funds may be more tax-efficient than fixed deposits. Arbitrage funds are taxed at 20% short-term capital gains (STCG) instead of the 30% tax on bank account interest or FD returns.
While optimizing tax, avoid aggressive tactics that might invite scrutiny from tax authorities. Here are some points to keep in mind:
Effective tax planning involves understanding your available deductions, structuring your salary optimally, and making informed investment choices. By aligning your financial plan with tax-saving opportunities, you can maximize post-tax income and work toward long-term financial stability.
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