Being self-employed and freelancing are attractive career options. You have the independence to make your own decisions, earn your own profits, and operate with relatively lower levels of stress.
From a financial point of view, a self-employed person has the flexibility to manage his taxation completely by taking full control of planning income and expenses in order to reduce tax incidence.
The question of finding ways to reduce tax liabilities is first and foremost on a self-employed person’s mind. But first, let’s understand the methods used to calculate his taxable income.
Tax incidence on self employed professional
It’s not easy for the self-employed or freelance professional to keep up with all the tiny details of his accounts. In a normal tax filing process, he must record each expense-related documents for eight years from the date of filing the return.
If his income is more than Rs. 25 lakh in AY 2016-17 (or Rs. 50 lakh in AY 2017-18), he must mandatorily perform a tax audit. It’s a cumbersome process as a self-employed person must track every little detail of his financial records over a long period.
In the regular income tax-filing process under ITR-4, the self-employed are allowed to claim several deductions from the total taxable income such as expenses incurred in carrying out their profession, interest on loan to carry out the profession, insurance for and depreciation of professional assets, salaries to employees, daily office expenses, and all sundry expenses related to conducting his business. Expenses such as internet bill, telephone bill, electricity bill and travelling expenses are also allowed to be deducted from the total income. But remember: for every such deduction, there must be a valid proof of expense.
Recently, the government of India has offered a choice of tax-filing to the self-employed professionals (those having income of less than Rs. 50 lakh in a year) by way of a presumptive tax system. It means the assessee has the choice of filing his taxes either in a regular way or through the presumptive tax method.
Under the presumptive tax method filed in ITR-4S, self-employed professionals are allowed to claim expenses at the rate of 50% of the total income, and the income tax is calculated on the remaining 50% percent while adding any interest income to it. Under this method you are not required to separately show any proof of expense, and you are not required to maintain accounting records.
Regular tax vs Presumptive tax: what should you choose?
If you incur expenses lower than 50% of your total income, then presumptive tax would definitely be the best option for you. Remember that once you opt for the presumptive tax method, you must continue with it for the next five years without break, and if you change the method before that, then you will not be allowed to re-select this method for the next five years. The presumptive tax system would suit you if you don’t want the burden of maintain accounts and proofs of expenses for the next eight years or if you want to avoid an audit of your books.
The regular tax method is very efficient if you claim expenses worth more than 50% of your total income and if you think that you can easily manage documenting your incomes and expenses.
Irrespective of whether you select the presumptive tax or the regular tax method, your income will be liable to TDS as usual, which is 10% of your receipts. If your total tax liability in a year happens to be less than your TDS paid, you could actually reclaim the excess tax paid from the IT Department.
Things to keep in mind to save maximum tax
While filing the ITR-4 i.e. through regular method, do not miss out claiming all the expenses related to your profession. Remember: these expenses would help you reduce your taxable income significantly, provided they are legitimate expenses and can be backed with proof. Plan your expenses well in advance to get the deduction benefit.
Similarly, if you are filing the ITR-4S, you are allowed to claim deductions under Sec 80C, 80CCD, 80D etc. post 50% deduction of total receipt. Therefore your effective tax planning could further reduce your tax liability.
Thoroughly analyse your expenses to understand which tax method suits you best. Consult your accountant or tax advisor before you opt between ITR-4 & 4S.
Tha author is CEO, BankBazaar.com