Investing in Fixed Deposit for tax saving? Beware! You may fall in a tax trap

There are many investment options through which you may reduce your taxable income by availing deductions u/s 80C of the Income Tax Act up to Rs 1.5 lakh in a financial year.

Investing in Fixed Deposit for tax saving? Beware! You may fall in a tax trap
One of the ways of tax saving is investing in Fixed Deposits for a period of 5 years or more, which are also known as tax-saving FDs.

There are many investment options through which you may reduce your taxable income by availing deductions u/s 80C of the Income Tax Act up to Rs 1.5 lakh in a financial year under the Old Income Tax Regime. One of the ways is investing in Fixed Deposits for a period of 5 years or more, which are also known as tax-saving FDs.

Along with tax-saving FDs, some other investment options available u/s 80C are Public Provident Fund (PPF), Sukanya Samriddhi Yojana (SSY), National Savings Certificate (NSC), Senior Citizen Savings Scheme (SCSS), Life Insurance Premium, Unit Linked Insurance Plan (ULIP), Equity Linked Savings Scheme (ELSS) and some expenses like Tuition Fee of children, repayment of Home Loan Principal etc.

While some investment options like PPF and ULIP are completely tax-free and come under the EEE (exempt, exempt, exempt) category, return on investments for some options – like tax-saving FDs, NSC, SCSS – is taxable. On the other hand, gains up to Rs 1 lakh on ELSS redemption in a financial year is tax-free and 10 per cent long-term capital gain (LTCG) tax is charged on excess gains.

The best way to save tax is by investing in the options having EEE features as along with the tax deductions on the investment amount, the interest/return and the maturity amounts are also tax-free. So, by investing in such a scheme, the investors will not create additional tax obligations.

However, if you invest in such an option, where the interest or return is taxable, you will have additional tax obligations due to the tax-saving investment itself.

For example, after availing all tax-saving options other than Section 80C, you have a gross income of Rs 6 lakh and to bring down the taxable income to Rs 5 lakh – to enjoy the full tax rebate – you have invested Rs 1 lakh in tax-saving FDs.

Assuming that the gross income remains stable at Rs 6 lakh, next year you have to invest more than Rs 1 lakh to enjoy full tax rebate as the interest on Rs 1 lakh you have invested in the previous year will be added to Rs 6 lakh to calculate the gross income.

Similarly, in the following year, you have to invest even more, as the interest on the investments made in tax-saving FDs in the previous two years will be added to the gross income to inflate it further.

This way, you may fall in a tax trap, where the interest on tax-saving FDs itself would cross Rs 1.5 lakh and you would fail to get any tax rebate.

If you don’t reduce your FD investments and continue to invest in tax-saving FDs, only due to the interest on FDs, you will enter the 20 per cent tax bracket.

So, it’s better to make proper plans and invest with a long-term vision and don’t just end up investing to save tax only for that particular year.

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