Representative image with the word 'tax'.
Credit: iStock Photo
While deductions and exemptions have long been familiar tools, tax credits are gaining prominence as a powerful means to reduce your tax bill legally. So, let’s delve into the intricacies of tax credits, demystify their benefits, and provide expert insights on how you can leverage them effectively.
What are tax credits?
Tax credits represent a direct reduction in your tax liability, unlike deductions or exemptions that merely lower your taxable income. When you claim a tax credit, it directly reduces the actual tax amount you owe. Think of it as found money—credits can even lead to a refund if they push your tax bill below zero.
Types of tax credits
1. Income Tax Credit
The income tax credit is a common variety encountered by taxpayers. If you consistently face higher tax obligations due to various reasons, any excess tax amount can be converted into a valuable tax credit. This surplus credit can then be applied to offset future tax liabilities without limitations. In other words, it’s a powerful asset that transcends your existing liabilities or tax bracket.
2. Child tax credit
While India doesn’t have a dedicated child tax credit, the government provides valuable benefits to families with children who pay taxes. These initiatives aim to enhance educational opportunities and increase literacy rates among children. Parents can avail deductions under sections such as 80C for tuition fees, 80D for health insurance premiums, and 10(14) for children’s hostel expenses, indirectly reducing their tax burden.
3. Input Tax Credit (ITC)
In the realm of Goods and Services Tax (GST), Input Tax Credit allows you to offset the tax paid on purchases against your tax liability. For instance, if you’re a manufacturer and incur taxes on the final product, as well as on materials purchased for production, you can claim the difference as an input credit. It’s a smart way to optimise your tax position and improve your business’s cash flow.
Leveraging tax credits effectively
To maximise the benefits of tax credits, consider the following strategies:
Stay informed: Keep abreast of tax laws and regulations to identify eligible tax credits that apply to your situation. Subscribe to newsletters, attend workshops, or consult with tax professionals to stay updated on changes in tax policies.
Keep detailed records: Maintain accurate records of expenses and transactions to support your claims for tax credits. Organise your financial documents systematically and retain receipts, invoices, and other relevant documentation for future reference.
Consult a tax professional: Seek advice from a qualified tax professional who can provide personalised guidance and help you navigate complex tax issues. A tax advisor can assess your financial situation, identify available tax credits, and develop a tailored tax strategy to minimise your tax liability.
Plan ahead: Strategically plan your finances to take advantage of available tax credits and minimize your overall tax liability. Consider timing major purchases or investments to optimize tax benefits and explore tax-saving opportunities such as retirement accounts, health savings accounts, and education savings plans.
Understanding tax credits is essential for every taxpayer. By leveraging tax credits effectively, you can legally reduce your tax bill and keep more of your hard-earned money.
(The author is Founder & CEO, Alice Blue)