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Is tax deductible the same as tax exempt?

It sounds similar since both can mean that you don’t pay tax and hence, you save tax, however, there is a difference in tax deduction versus tax free or tax exemption.

It is said that death and taxes are the only two things certain in life. Clearly, it’s an exaggerated statement, but nevertheless, the fact is we all must pay our taxes. Taxes are a given, but there are ways in which you can make your tax liability more efficient. If you are a regular investor, you’ll know that there are various types of investments which can help you save taxes. 

In general, there are two ways in which you can save taxes through your investment. Firstly, the investment you make could be tax-deductible and secondly, the gains from an investment may be tax-free. It sounds similar since both can mean that you don’t pay tax and hence, you save tax, however, there is a difference in tax deduction versus tax-free or tax exemption. 

Tax-deductible

A deduction may be thought of as reducing the value from a whole. There are some investments which qualify for a deduction under our Income Tax Act Section 80 C. The deduction is for the value of the investment from your taxable income. The total deduction has a prescribed annual upper limit.

For example, under section 80 C you can deduct up to a maximum of Rs 1,50,000 invested in equity-linked savings schemes or public provident fund (PPF) or post office schemes or five-year fixed deposits. This is deducted from your total taxable income, thus reducing your tax liability. 

The returns you earn from these investments may or may not be tax-free or tax-exempt. Moreover, while there is an upper limit on the tax deduction each year, you are free to invest more or less in the security of your choice for the purpose of tax saving. 

Not paying any tax on your investment gains is always a great lure, but don’t let it become the primary reason behind your investment choice. Even while selecting an investment for your tax-deductible income, ensure you pick one that ticks other requirements too like flexibility and growth. 

Tax exemption or tax-free

This is when any income that you may have earned through investments or otherwise is not taxed at all. For example, your income up to Rs 5 lakh in a year is tax-exempt or in other words, no tax is charged on that portion of your income.

Similarly, the interest you earn from tax-free bonds are tax-exempt and so is the interest earned from PPF. Till a few years ago, long term capital gains or long-term profits from equity investing were also tax-free, but are now liable for 10% tax on gains. 

Tax-free income is desirable of course but it is an available option in very select investments. 

Not paying any tax on your investment gains is always a great lure, but don’t let it become the primary reason behind your investment choice. Even while selecting an investment for your tax-deductible income, ensure you pick one that ticks other requirements too like flexibility and growth. 

Know your taxes, but don’t prioritise tax when it comes to setting long term investment goals. 

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