Tax-Free Income: 10 Types of Earnings Exempt from Tax You Should Know Before Filing Your Return

Income tax is a significant aspect of financial planning and management for every individual, as it applies to a wide range of incomes. Most people are aware that income tax is levied on their salary, but it also extends to other forms of earnings, such as interest from savings, income from property, side businesses, and capital gains. However, there are several income sources where no income tax is applied. Understanding these exemptions can help individuals optimize their financial strategies and make the most of the available tax benefits.

Overview of Income Tax and Exemptions

Income tax in India is levied on various types of income, including salary, interest income, rental income, capital gains, and profits from businesses or professions. However, the Indian Income Tax Act provides certain exemptions and deductions that allow individuals to reduce their taxable income. These exemptions are crucial for financial planning, as they help in legally minimizing tax liability. Below, we will explore some specific incomes on which no tax is levied and discuss their conditions and criteria.

1. Earnings from Employees’ Provident Fund (EPF)

The Employees’ Provident Fund (EPF) is a popular retirement savings scheme for salaried employees in India. Contributions made to EPF are eligible for a tax deduction under Section 80C of the Income Tax Act, and both employee and employer contributions qualify for exemptions. However, the exemption on the employer’s contribution is limited to 12% of the employee’s basic salary. If the contribution exceeds this percentage, the excess amount becomes taxable. The interest earned on the EPF account is also tax-free, provided certain conditions are met, including the employee not withdrawing the funds before completing five continuous years of service.

Additional Detail: If an individual withdraws EPF before completing five years of continuous service, the amount becomes taxable unless the withdrawal is due to specific reasons like the employer’s insolvency, or the employee shifting jobs where the EPF system doesn’t exist. In such cases, the employee is not penalized with tax on the withdrawal.

2. Exemption on Long-Term Capital Gains (LTCG) from Shares or Equity Mutual Funds

Investments in equity shares or equity-oriented mutual funds can offer significant tax benefits, especially if held for the long term. Any capital gains realized from selling these investments after a holding period of one year are termed Long-Term Capital Gains (LTCG). Under current tax laws, LTCG of up to ₹1 lakh in a financial year is exempt from tax. Gains exceeding this threshold are taxed at a rate of 10% without the benefit of indexation.

Additional Detail: The introduction of the LTCG tax in 2018 marked a shift from earlier tax provisions where long-term capital gains from equities were entirely exempt. Despite this, the ₹1 lakh exemption continues to offer a significant relief to small investors. It’s important to note that short-term capital gains from equities (i.e., gains from investments held for less than one year) are taxed at 15%.

3. Gifts Received During a Wedding

Marriage is considered a significant life event, and as such, gifts received by an individual during their wedding are exempt from income tax. However, there are specific conditions for this exemption. The gifts must be received in connection with the wedding, and if received outside a reasonable time frame (e.g., six months after the wedding), they may not qualify for the exemption. Additionally, the value of the gift should not exceed ₹50,000.

Additional Detail: This exemption applies regardless of whether the gift is in the form of cash, property, or valuables. However, gifts from non-relatives may be subject to scrutiny if they seem unusual or excessively high, as such gifts could potentially attract the attention of the tax authorities.

4. Interest Earned on Savings Accounts

Interest earned from savings accounts in banks or post offices is partially exempt from tax under Section 80TTA of the Income Tax Act. The exemption limit is ₹10,000 for regular taxpayers. Senior citizens, however, enjoy a higher exemption limit of ₹50,000 under Section 80TTB.

Additional Detail: If the interest earned exceeds the exemption limit, the excess is added to the individual’s total taxable income and taxed according to their applicable slab rate. It’s also worth noting that this exemption applies only to interest from savings accounts, not from fixed deposits or recurring deposits, which are fully taxable.

5. Profit from a Partnership Firm

For individuals who are partners in a firm, the share of profit they receive from the partnership is exempt from income tax. This is because the partnership firm itself is subject to tax on its profits. However, any salary, commission, or bonus received from the firm is taxable in the hands of the partner.

Additional Detail: The taxation of partnership firms is distinct from that of companies. Firms are taxed at a flat rate of 30%, plus applicable surcharges. The share of profit that partners receive, known as ‘exempted income,’ avoids double taxation since it has already been taxed at the firm level.

6. Life Insurance Claims or Maturity Amount

The amount received from a life insurance policy, whether as a death claim or on maturity, is exempt from tax under Section 10(10D) of the Income Tax Act. This is applicable provided that the premium paid for the policy does not exceed 10% of the sum assured. If the premium exceeds this limit, the policyholder may have to pay tax on the proceeds.

Additional Detail: For policies issued after April 1, 2012, the exemption is only available if the annual premium is not more than 10% of the sum assured. In cases where the policyholder is insuring a person with disabilities, the limit is relaxed to 15%.

7. Voluntary Retirement Scheme (VRS) Compensation

Employees opting for voluntary retirement (VRS) can receive compensation of up to ₹5 lakh without attracting income tax. This exemption is available to employees of both government and public sector undertakings (PSUs). However, private-sector employees may not be eligible for this tax benefit.

Additional Detail: The ₹5 lakh exemption limit applies to a one-time payout under VRS. If an employee receives VRS compensation in multiple installments or opts for VRS more than once, the exemption applies only once.

8. Property Inherited through a Will or Gift

Income tax is not levied on property, cash, or valuables inherited through a will or received as a gift from family members. This is because the inheritance itself is considered non-taxable under the current tax laws. However, any income generated from the inherited property, such as rent or interest, is subject to tax as per the recipient’s tax slab.

Additional Detail: In the case of property received as a gift, the exemption applies only if the gift is received from specified relatives. Gifts from non-relatives are taxable if the value exceeds ₹50,000.

9. Agricultural Income

Agricultural income is fully exempt from income tax in India. This includes income derived from the sale of agricultural produce, rent from agricultural land, or income from farmhouses. However, income from non-agricultural activities, such as processing produce beyond the basic agricultural operations, may not qualify for exemption.

Additional Detail: Agricultural income can be a contentious issue when mixed with non-agricultural business activities. Tax authorities may scrutinize income that is claimed as agricultural if it includes elements of non-agricultural business.

10. Business Expenses on Food and Entertainment

If you are a business owner, the cost of providing food or entertainment to clients, customers, or business associates during the course of your business activities can be claimed as a business expense. By maintaining proper documentation such as bills and invoices, you can reduce your taxable income by deducting these expenses.

Additional Detail: This exemption applies only to legitimate business-related expenses. Personal entertainment or food expenses cannot be claimed for tax deductions.

Conclusion

Understanding these tax exemptions and how they apply to your financial situation can lead to significant tax savings. These provisions are designed to encourage long-term investments, promote savings, and support certain life events. By taking advantage of the available exemptions, taxpayers can ensure they are not overpaying their taxes while remaining compliant with the law. Always consult a tax professional to ensure you are correctly applying these exemptions to your specific financial situation.