Income tax issue- small income can trigger large tax liability

India's income tax rules are unfair- while govt claims up to 12.75 lakhs is income free, moment your income crosses this limit, all your income from 4 lakhs and above will be taxed.

Recently I help a senior citizen file their income tax return. They had pension income and more importantly, lots of interest coming in from their bank fixed deposits, as all their life savings were invested in FDs.

Unfortunately, their pension income + interest income marginally crossed 1275000 limit and reached close to 13 lakhs. Had they earned below 1275000, net tax liability would have been zero. But because they earned 25000 more, all income from 4 lakh and above are taxed, resulting in about 78000 INR in tax liability. Essentially, had they earned 25k less in interests, they could have saved a net 53000 rupees.

Our banks do not give a provision where we can give the interest back to bank. It would have been such a profitable business for banks, as well as customers in above cases.

Many professionals who get marginal salary increase also fall into same trap. With 2-3% hike your taxable income crosses 1275000 and results in 60-80k tax liability for the additional 10-20k hike you got.

Solution: 

This issue could have been avoided if Govt were to take tax only on income above 1200000 INR, but that may not happen. Below is what I think people can do.

Salaried folks:

Option 1: Talk to HR, negotiate for some indirect benefits instead of cash salary- maybe cab reimbursement, home office setup expense reimbursement or higher health insurance coverage etc, so that your taxable income stays below 1275000 and you get some other non cash benefit instead

Option 2: Employer contribution to NPS is excluded from taxable income in new regime. Max 14% of your basic. Use this option to reduce your taxable income a bit.

Option 3: If your taxable income falls just under 1275000, you've to ensure that your savings, FD interest, dividend income doesn't cross the border. In such cases maybe transfer some money to some other family member who do not have taxable income or invest in mutual funds which are taxed as Capital Gain and not investments

If you have any other thoughts do share.

For retired folks:

Best way is to move your investments to Mutual funds. Mutual fund returns are taxed under capital gains, with 1.25 lakh per year exempted for long term capital gain.   Also mutual fund returns are taxed only when they are redeemed, so you have option NOT to redeem and let it compound. Using this you can reduce overall tax liability a bit.

Disclaimer: I am not any certified financial expert and views expressed above are my own based on personal experience and observations. Please do your research and use your discretion. Investments carry their own risk. Taxation rules also tend to change every year, so need to adapt time to time.