Blog - Understanding Tax Savings

Introduction:

Salary break-up is an HR initiative by design. It’s done to help you save taxes, wherever possible. As simple as it sounds, layering your salary structure can be a bit complicated. It can be quite the rally of matching your expectations of a higher take-home salary; while keeping your tax cuts to minimum.

Let’s try to make this an easy drill by giving you a basic outline of a typical salary structure:

Basic Pay: Your basic pay is the fixed income component, and all contributions such as PF, etc are based on this number. This is a taxable component. But, HR’s salary design includes ways where you can save tax. Your basic pay forms the foundation of all your future salary hikes.
Standard Deductions: You’ll see a component for standard deductions in your salary slip. This is the built-in tax deduction, which you can take home while prepping up for your year-end taxes.
HRA: Known as House Rent Allowance, HRA comes with some exemptions under Section 10(13A) of the Income-Tax Act, 1961. To claim this exemption, you’ll need a proof of your rent receipts.

The exemption rule is applicable to the minimum extent of:

For metros, it is 50 percent of salary and 40 percent for non-metros
Amount of HRA received -- you can negotiate for a higher HRA if you wish to match the amount with your house rent.

LTA: This is another popular tax-saving allowance, known as LTA or leave travel allowance. It is paid to cover your holiday expenses, such as train tickets or air travel, etc. This tax saving benefit is only available on domestic travel.
Allowance or Benefits: As a salaried employee, you may also get other allowances such a dearness allowance, conveyance, mobile phone, internet, car allowance, and so on. Most of these allowances are non-taxable. The only requirement is that these allowances must be defined under the Income Tax Act. Also, one must note that some allowances may or may not be part of your Gross Salary. You may, however, request your employer to include the same in your salary structure to cut down the taxes.
PF contribution: At present, the PF contribution stands at a fixed figure of 24 percent of your basic pay. Here, you make a contribution of 12% towards your PF account. This figure is deducted every month from your salary. Alongside, your employer will contribute the remaining 12%. Your income from the PF account is eligible for tax deduction under section 80C of the Income Tax Act, 1961.
Reimbursements: These are over and above your salary. It consists of fuel bills, meal vouchers, data access and so on. All reimbursements paid against actual bills are completely exempted from income tax.
Bonuses: This a performance-linked component, and in some cases companies may offer joining or retention bonuses.

Section 80C gives you multiple options to save taxes, and also save for your future.

One of them is your Employee Provident Fund. The interest you earn on your income is also exempted from tax.

Gross pay v/s Net Pay

These numbers pretty much set the course of your career graph. It is the summation of your present salary structure, bonuses, perks, pension policies and so on.

Gross Pay

Gross Salary is inclusive of Basic salary, HRA and other benefits/allowances. It is the amount paid before any tax or other deductions including bonuses, PF, gratuity and other perks.

Net Salary

It’s basically your take-home salary or the in-hand salary. It is what your bank account is credited with on your pay day.

Your take-home salary is calculated after deducting Income Tax at source, provident fund (12% of your Basic Pay), professional tax and other deductions as per your company policy.

Here’s a tip, when negotiating your salary -- Ensure that your basic salary is 50-60 percent of your gross salary.

The case of missing numbers

Your math is likely to be challenged when it comes to your ‘take-home’ or ‘in-hand’ salary. More often than not, the number seems to be different than the actual expectation. The reasons for this could be one too many. But, the good news you can claim all those missing numbers. All you need to do is make the right investments and restructure your salary to avail maximum tax-saving benefits.

You can discuss, understand and negotiate with your HR to ensure that you claim those missing numbers. For this, ensure that your salary is loaded with allowances. At this point, we’d also like to clear that allowances needn’t necessarily be over and above your Gross salary. Allowances can be a part of your CTC -- Cost to Company. Employees can select a number of tax friendly components to cut down on the overall taxes. Most of these allowances are exempted under the Income Tax Act, 1961.

Plan wise, save more

The Income-tax Act is kinder than you would think. You can save close to Rs 1,50,000 on taxes and claim tax-saving benefits up to Rs 80,000 through your salary.

The most popular sections include:

Section 80C

This section gives you multiple options to save taxes, and also save for your future. One of them is your Employee Provident Fund (PF). The interest you earn on your income is also exempted from tax.

Other vehicles under Section 80C include a Public Provident Fund (PPF), National Pension Savings Scheme, Sukanya Samruddhi Scheme and more.

In addition to the government-linked savings scheme, you can also opt for a ELSS mutual fund -- Equity Linked Savings Scheme. These scheme come with a lock-in period of 3 years and the saving under such schemes are exempted from tax. Most leading mutual fund houses in India offer ELSS schemes. These schemes will not just give you access to own an asset class, but also beat inflation over the long term.

Under Section 80C, you can save taxes as per your investments:

Tax savings = Investments X Tax Rate

Here’s some calculation to simplify this investment jargon:

• Tax that you pay = 20.8 percent

• Total investments: Rs 1.2 lakh under the provisions provided by 80C

The total tax saved will be Rs. 24,960.

Section 80D -- Health insurance

This section accounts for deductions made towards health insurance premiums. This includes premiums made for towards yourself and your dependant family. At present, you can avail a maximum deduction of Rs 25,000 per year.

Section 80E -- Education Loan

This deduction is towards interest paid on education loan for higher studies. You can claim this deduction for up to a maximum of 8 years or till the entire amount is paid off, whichever is earlier.

Section 80EE -- House Loan

If you are a first time home owner, you can claim deductions on your interest amount under Section 80EE. Here, you can avail a tax deduction of up to Rs 50,000. Tax savings on the amount spent

Some spends such as donations are exempted from tax under section 80C. These donations can be made towards certain NGOs and political parties. However, these donations need to fulfil some criteria. And, if it does, NGOs will most likely inform you at the time of donations.

In addition to to your acts of kindness, you can also save taxes on your daily essential spends such as food, travel, house loan, auto lease allowance, spends towards mobile phones and internet. All this falls under the benefit allowances offered by your company.. And, to make the best of this, you need to negotiate with your HR to understand the employee tax-saving benefits.

Tax saves for business owners

As a salaried employee, one is at the advantage of claiming benefits through their organisation. However, for business owners life isn’t so glum. Just like any other salaried individual, you can avail tax saving benefits on home and education loan, health insurance premiums, LIC and PPF savings, mutual fund investments and more.

In addition to this, you can save taxes by ensuring that you limit your cash payments to up to Rs 20,000 in a single day. Further, you get multiple benefits for additional depreciation on your assets under section 35AD, etc.