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.
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.