What is Tax Planning? Its Objectives and Types

The major objective of tax planning is to reduce your tax liability by reducing your net taxable income. This can be achieved by making tax saving investments or claiming deductions for specific expenses like Section 80D deductions as per applicable income tax laws. There are a number of such investments including government-backed schemes that can help you plan your taxes effective, which we will discuss in a subsequent section of the blog.

Another goal of tax planning is to reduce the possibility of litigation by tax authorities. India’s Income Tax Department has the right to issue notices in case you are allegedly evading taxes i.e. avoiding your due tax payments by illegal means. In case you are unable to provide adequate justification or proof in reply to such a notice, tax authorities can pursue court cases resulting in hefty fines and even jail time. Since tax planning is a legal way to reduce your tax outgo, it can help you minimize and even eliminate the possibility of litigation by tax authorities. .

Paying the right amount of tax means that you will have more money to achieve various financial goals. Moreover, since tax planning also involves making long-term tax-saving investments such as various Section 80C investments. With such investments you can also potentially get the dual benefit of tax saving and long term wealth creation. So if implemented correctly, tax planning can help boost your savings in the long term.

While typically, long-term tends to mean a multi-year strategy, in the case of tax planning, a long-term strategy begins at the starting of the financial year. For best results, this type of tax planning strategy has to be followed throughout the year in a consistent. Examples of tax saving investments that can be made following this strategy include SIP in ELSS mutual funds, monthly deposits into public provident fund account, systematic investments in National Pension System, etc. The key benefit of this strategy is that you can make relatively small investments that have minimal impact on your monthly budget and still reach your tax saving goals for the financial year.

The short-term tax planning typically involves making just a single or very few relatively large lump sum investments or expenditures to reach your tax planning goals. Quite often these expenditures or investments are undertaken at the end of the fiscal year. The key limitation of this type of tax planning strategy is that you are required to invest a large amount to achieve your tax planning goals. While this has the potential of upsetting your monthly budget, it might be unavoidable in some cases. For instance, payment of life insurance premium and health insurance premium are usually payable only once a year and the same is true for investments such as Unit Linked Insurance Plans (ULIPs). This strategy can be better suited for individuals such as the self-employed who need to make tax-saving investments even though they have seasonal or irregular cash flow.

As an investor, when you have a specific goal to attain and ensure that you gain all the benefits through your investment, it falls under purposive planning. In this strategy of planning your taxes, you select tax saving investment schemes that will help you meet specific investment goals and/or diversify your assets based on your other investments

Permissive planning is a strategy that helps you plan your tax saving investments such that you can claim the maximum permissible deduction limit under different sections of the Income Tax Act, 1961. The key limitation of this strategy is that it primarily focuses on saving tax and does not consider the suitability of a specific type of tax saving option towards achieving the financial needs and goals of a tax payer.

The Income Tax Act, 1961 offers various tax exemptions and deductions not just for those making investments but also for those seeking tax relief when repaying an education loan or home loan or paying children’s tuition fees. Another example of a permissive tax saving strategy is making donations to specified institutions. While donations provide tax deduction benefits, the tax payer does not get other benefits like long-term wealth creation from it.

Based on the above discussion, you might be wondering what are the various options in terms of investments and expenditures that can offer tax deduction benefits. Read on to find out.