Any law abiding citizen is required to pay taxes in order to enjoy the benefits of civic society and government services. Evading taxes is also an illegal activity, and efforts must be taken to ensure that you never commit this crime.
However, even as you start paying taxes, it is important to remember that the government offers various legal recourses that enable you to reduce the amount you pay as taxes. The definition of tax planning involves the analysis of a financial plan or situation, through which process you ensure that the least amount is taxable.
Tax planning is an essential activity for all taxpayers, since by minimizing the amount you pay as taxes, you are able to save more and thus, have a larger corpus at the time of retirement when you no longer have a steady income flowing in each month. The importance of tax planning is huge since it enables you to comfortably assess your income, the amount you are due to pay in taxes and the amount you are able to save.
Tax planning is usually undertaken as an annual exercise. Read on to learn about the objectives of tax planning and how you can legally and carefully ensure that the amount you spend on taxes is minimal.
1. Minimizes requirement for litigation:
Friction is always likely to occur between the taxpayer and the tax collector. As a result, it is best to avoid any action which may result in litigation, wherein the taxpayer is involved in legal disputes with different organs of the government. The scope of tax planning includes ensuring diligence and compliance with tax laws.
2. Reduces tax liabilities:
Among the key features of tax planning, the most important is that it reduces the amount of tax liabilities on you. Through careful tax planning annually, you can easily assess the amount you are required to pay and all the different ways in which you can get exemptions or deductions on the taxes you are liable to pay. If done right, financial planning can significantly help you in reducing your tax burden.
3. Ensures economic stability:
The government is able to run the affairs of the country in an efficient manner owing to the taxes that people willingly pay. Public facilities and services can be organised and provided by the government, owing to this constant cash flow in the form of taxes. One of the features of tax planning is that it ensures that while your individual tax liabilities are reduced, the government is still earning enough to be able to offer services to the country and citizens.
4. Leverages productivity:
One of the chief features as well as objectives of tax planning is to channelise funds in a manner that they are diverted from channels where the taxation is higher, and towards channels through which higher income can be generated since taxes are lower.
The government also offers several routes through which taxpayers can reduce their taxation burden. Tax planning examples in India include Section 80C of the Income Tax Act, 1961, through which tax benefits are available on deposits into five year bank deposits, public provident fund, National Savings Certificate and investments into Equity Linked Savings Scheme (ELSS).
Since the scope of tax planning is vast, there are several types of tax planning methods that different people have a preference for. Read on to learn about the different types of tax planning, and how they offer an advantage over the other types.
5. Short-range Tax Planning:
This is the most common type of tax planning and is undertaken by every investor at the end of the financial year. This method does not take into account long-term investment commitments, but can help with substantial tax savings.
6. Long-term Tax Planning:
Long-term tax planning is almost the reverse of the short-range tax planning mechanism. Under a long-term tax planning endeavour, a plan is drawn up at the beginning of the fiscal year which aims to reduce tax liabilities. The investor then has to stick to the plan in order to ensure the highest tax savings. It is important to remember that with this type of tax planning, it will often be a while before you observe any benefits.
7. Permissive Tax Planning:
Indian law offers enough opportunities to taxpayers to avail deductions and exemptions in terms of the taxes they are liable to pay. Several sections under the Income Tax Act, 1961, empowers taxpayers to legally reduce their tax liabilities. Permissive tax planning involves assessing the different instruments under which it is possible to get tax exemptions and tax deductions, and then creating a tax plan through which you can avoid the most significant burden of taxation.
8. Purposive Tax Planning:
Purposive tax planning is the most intentional and elaborately planning mechanism. Purposive tax planning involves identifying the best investments for your requirements, and how they can best help you save on taxes. A purposive tax plan even includes details on how best to diversify the investment, or when would be the best time to switch assets.
While there are different types of tax planning that offer different benefits and operational ways, the common point within all these plans is that they are all aimed towards reducing the tax burden on you.
The most prominent tax planning example in India is the benefits that can be availed under the Income Tax Act, 1961. As previously mentioned, Section 80C offers deductions and exemptions on various investments made.
Section 80D of the same Act enables people to save taxes on the premiums they have paid towards health insurance. Section 80E is geared towards reducing taxation burden on the interest paid towards an education loan.
With the government themselves facilitating and encouraging taxpayers to reduce their tax liability, it is important that taxpayers themselves take advantage of these benefits. Tax planning is a crucial financial activity that must be undertaken in order to ensure the least amount is lost on taxation. Remember that the lesser you spend on taxes, the more money you will be in a position to save.