Tax Deductions vs. Exemptions – Differences, Importance, and Examples

difference between tax deductions and tax exemptions

If you have opted for the old tax regime and are planning to reduce your taxable income, you will know the importance of deductions and exemptions.

Contrary to popular belief, tax deductions and exemptions are not the same. 

While both of these help you save on taxes, their purpose and impact varies. It is important to know the difference between them in order to make the right financial decisions.

What are Tax Deductions?

what are tax deductions

Tax deductions are expenses or income that can be deducted or removed from your taxable income. 

This, in turn, reduces the amount of tax that you need to pay.

Deductions include the amount invested in PPF, ELSS, Medical Insurance, etc.

Suggested Read: How to Save Taxes Beyond Section 80C

For example, let’s say that your annual taxable income is Rs. 5,00,000. You have decided to invest Rs. 1,00,000 per year in PPF.

Due to your investment, the amount you will be taxed for has reduced from Rs. 5,00,000 to Rs. 4,00,000. This in turn reduces the amount of tax that you need to pay.

What are Tax Exemptions?

what are tax exemptions

Tax exemptions are sources of income that are not taxed. This means that you will not have to pay any tax on the income right from the get-go.

Some examples of tax exempted options are agricultural income, House Rent Allowance(HRA), Leave Travel Allowance (LTA), etc.

Let us assume that your annual income is Rs. 6,00,000. Out of this, if Rs. 50,000 is agricultural income, then you will be taxed for Rs. 5,50,000 and not the entire amount.

In this way you will be able to save on the tax that you need to pay for the year.

Suggested Read: How to Save More on Income Taxes

things to consider

  • Income tax deductions are only offered to individuals who opt for the old tax regime
  • Deductions and exemptions are not the same as tax rebates or TDS
  • Income tax rebate refers to the refund that you can get incase you pay more tax than you are liable for
  • TDS or Tax Deducted at Source is when tax is collected directly from the payer before paying the balance to the payee
  • You can reduce your taxable income significantly by taking note of the deductions and exemptions available to you

In Conclusion

As per the Income Tax Act of 1961, individuals are offered tax deductions and exemptions. These factors will help reduce the amount of tax one needs to pay. Schemes such as Sec 80C, Sec 80D, Sec 80G all fall under income tax deductions. HRA, LTA, agricultural income, etc, come under income tax exemptions.

It is important that you take note of all the deductions and exemptions available to you as part of your annual financial planning.