• Notification Date: 26-09-2024
• Notification No: N/A

Income Tax: How can middle-class employees optimize their taxes?

Income Tax: Employees can optimize their salaried taxes by taking advantage of deductions such as 80C and 80D and by contributing to state pension schemes. Understanding proper salary structure and investment taxation can further increase post-tax income.  

Effective income tax planning allows employees to optimize their salary tax. An important aspect of tax planning for middle-class employees is to utilize deductions and exemptions within the limits of the law, defer taxes, and take advantage of various tax arbitrage opportunities.  

Opportunities for salaried employee tax to save on taxes are limited compared to self-employed individuals. Taxes can play a significant role in the final value of your net worth. 

This is divided into three parts:   

• Deductions and salary structure.   

• Tax Deferral and Tax Arbitration.   

• Things: Which strictly not be done.   

Deductions and Salary Structure   

The most common deductions used by people of middle class employees are 80C and 80D. There are several ways to claim the 80C deduction. These include employee tax provident fund contributions, public provident fund contributions, child tuition fees, mortgage repayment for home loans, equity-linked savings schemes, national savings certificates, and fixed income tax savings. Under 80D, you can also claim deductions for your own health insurance premiums and your parents' health insurance premiums up to a certain limit.  

The above two, 80C and 80D, are used by almost everyone. The most important deduction that employees miss out on is the State Pension Scheme. This deduction applies to both the new and old tax regimes. The government has a clear plan to abolish the old tax regime, and the new tax regime is one of the few ways you can save on taxes. Please note that for 2024-25, the threshold for the new regime has been reduced to 14% of the threshold, while the threshold for the old regime remains at 10%. The most important information in this context is that employees can make retrospective contributions from 1 April 2024.  

All salaried employee tax who have taken a home loan can also avail of Section 24 and claim up to Rs 200,000 as home loan interest deduction.  

A proper salary structure also allows for significant income tax planning maneuvers:  

Basic Salary: This is the basis of CTC. Basic Salary determines the employer's contribution towards the provident fund and the National Pension Scheme.    

A higher basic salary gives you more tax free income. Because employer's contribution towards employee's provident fund (12% of basic salary) and National Pension Scheme (14% of basic salary, new tax regime) is entirely tax.  

Employee tax free total employer's contribution towards approved provident fund (including employer's provident fund), National Pension Scheme, and approved superannuation funds combined during a financial year is surpassed at Rs 7.5 lakh.  

Please understand that if your CTC is more than 60-70 lakh per annum, the higher is better rule does not work; in that case, you need to plan better. Also note that a higher basic salary gives you more retirement benefits and paid leave on leaving or changing jobs.  

Employer contribution to provident fund: Some employers contribute ?1800 as lump sum contribution to EPF. These employees should speak to their HR/payroll department to see if they are willing to increase the amount to 12% of their basic pay. This change will remain in the overall CTC and will reduce their net pay.  

Under the old tax regime: Rental Allowance (HRA) and Travel Allowance (LTA) could be used to reduce the tax payable.  

Tax Deferral and Tax Arbitrage   

This is about tax on capital gains. The final value can be significantly affected by the use of tax deferrals and lower tax rates. For example, tax deferral is not possible on fixed deposits, but it is possible in the case of pension funds.  

If you are actively investing in equities, any fluctuations will be tax free. However, if you invest in equities through a mutual fund structure, all the fluctuations that the fund manager makes in that structure are tax free. Taxation only comes into play when you sell the shares.  

Similarly, dividends from equities are taxed, but the dividends received by the investor companies in an investment fund structure are not taxed. Let us take this as an example of tax arbitrage. In short-term parking, arbitrage funds are taxed at 20% (STCG), whereas in bank accounts and fixed deposits, interest income is taxed at 30%. 

Things strictly not to be done   

• Many employees claim wrong HRA exemptions. Understand that this can have consequences.    

• Claiming tax refund under Section 80G through donations to NGOs/political parties or cash withdrawals.    

• Do not deal with CAs who charge a percentage of your tax refund as commission.