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Tax saving is one of the benefits that everyone looks for while making investments, or while planning expenses. While doing so, people often get confused with terms like tax deductions and tax exemptions, as these seem to have similar implications.
As a result, they usually resort to letting their accountants, parents, and friends do the tax filing for them as the terms can be quite difficult to understand and make any sense of. However, understanding these terms is important to take maximum advantage of available schemes and policies.
Through this article, readers can understand the difference between a tax deduction and tax exemption and also how it impacts one's taxes.
Before understanding the difference between exemption and deduction in income tax, take a look at what tax deductions are.
Tax deductions are some specific investments and expenses, which can be deducted from one's taxable income, hence lowering it. They are usually allowed to encourage retirement planning, or other long-term financial health among citizens.
For example, let’s say a person's income is Rs. 10 lakhs and they invest 1 lakh out of it in a public provident fund scheme. As per section 80C of the Income tax act, this Rs. 1 lakh is deducted from their taxable income and the taxable income remains as Rs. 9 lakh
Here are some of the tax deductions available under various sections of the Income Tax Act, of 1961. Note that the list is not an exhaustive one.
Investing in Public Provident Fund (PPF), Equity Linked Saving Scheme (ELSS), Home Loan Principal Amount Repayments, National Saving Certificate (NSC), Employee Provident Fund (EPF), Pension plans and Property Stamp Duty and Registration Fees up to Rs. 1.5 lakhs annually can be deducted from one's taxable income.
This is over and above the standard deduction of Rs. 50000 available to all taxpayers. Any amount invested in the schemes as per the provisions of this act is deducted from the taxpayer's income, hence reducing their overall tax liability.
Premiums ranging from Rs. 25000 to Rs. 1 lakh paid towards health insurance of self and family are tax deductible. The amount is dependent on the age of the insurer. There are other deductions available for the treatment of disability of dependents and for specified diseases.
Interest paid on education and homes for first-time home buyers can also be deducted from taxable income. This tax deduction is granted by the government to encourage higher education by students whose parents cannot afford to pay the expensive fees. Similarly, the tax deduction on interest payments on a housing loan is provided to encourage investment in domestic real estate.
This section enables one to claim tax deductions on contributions to social causes and political parties. The official website of the Income Tax Department contains the details of all the notified places of worship, charitable institutions, etc. that are covered under the section.
These deductions are a way that government provides its support to such organizations and social activities.
Saving account interest income of up to Rs. 10000 can be deducted from taxable income.
Now to understand the difference between exemption and deduction in income tax, let’s first understand what tax exemptions are.
Certain portions of one's income are tax-free at their very origin. Such portions are tax-exempt. The taxpayer does not have to spend this income or invest it in any manner to be able to claim the exemption.
Here are some examples of the same:
LTCG on Equity mutual funds are exempt from taxation up to a limit of Rs. 1 lakh per annum.
HRA is part of an employee's salary and is exempt from Income tax if they live in a rental house.
Some employers pay employees a Leave Travel Allowance which can be used for travelling during leaves. This exemption can only be availed once in 4 years.
All agricultural income in India is exempt from any taxation. This is because agriculture is the only source of income for a large part of rural India. As well, the country is entirely dependent on it for food security which would become expensive in case of an agricultural income tax.
An income of Rs. 5 lakhs and below is completely exempt from income tax. This means that if one has an income of Rs. 7 lakhs, Rs. 2 lakhs is taxable income.
Tax exemptions apply to specific kinds of income, while deductions apply to specific kinds of expenditures and investments. While the terms are used interchangeably by many, they are entirely different.
Tax exemptions make certain kinds or amounts of income tax-free, while tax deductions implore one to save or invest in certain schemes or policies to get tax benefits.
A new tax regime has been introduced in Budget 2023. As per this regime, various tax exemptions and deductions such as HRA, LTA, Section 80C, etc. have been done away with. However, the income exempted from income tax has been increased to Rs. 7 lakhs.
While one has the option to continue to file taxes under the old tax regime, unless the taxpayer specifies the same, the default applicable regime will be the new one.
Taxpayers must choose one of the tax regimes after taking into account the difference between exemption and deduction in income tax as available in the old regime against those available in the new regime for their income. It is advisable to choose one regime over the other only after calculating the tax payable under each of these regimes.
While the terms exemption and deduction may seem similar, with the impact of reducing the total tax payable by a person, the two are completely different concepts.
Understanding the difference will not only help plan one's savings better but can also help one in salary negotiations. One can also distribute one's income from sources other than salary to make use of deductions and exemptions. Tata Capital offers many savings plans such as ELSS mutual funds that can be leveraged- both for their inherent benefits as well for tax savings. One must keep different deductions and exemptions while planning investments and wealth creation to utilise optimal tax benefits.
Policies, Codes & Other Documents