Tax deduction vs. tax exemption: What’s the difference?

  • Income Tax

Introduction

Looking for tax-saving investments? In that case, you’ll no doubt come across the terms ‘tax deduction’ and ‘tax exemption.’ At first glance, they appear to be quite similar, isn’t it? But the truth is, they’re quite different from each other. The common thing is that they’re both based on the provisions of the Income Tax Act, 1961.

Let’s take a closer look at tax deduction1 and tax exemption1, and see how they compare.

Tax deduction vs. tax exemption: The meaning


Tax deduction

Tax deductions are specific items that can be deducted from your income. These items are generally expenses or payments made towards certain investments.

Tax exemption

Tax exemptions are specific items that are excluded from taxation. These items are generally allowances or other amounts earned as income.

Tax deduction vs. tax exemption: How do they work?


Tax deduction

When the eligible amounts are deducted from your income, your total taxable income comes down. As a result, the amount of tax that you need to pay is also reduced. All in all, you enjoy the benefit of reduced taxes when you claim tax deductions.

For instance, say you are eligible to claim Rs. 40,000 as a tax deduction under the Income Tax Act, 1961. And say your total income is Rs. Rs. 4,30,000. After claiming the tax deduction, your total tax deduction would be Rs. 3,90,000.

Tax exemption

These items are essentially tax-free. So, you do not have to pay taxes on such income at all. Some kinds of income may be partially exempt from tax, while others may be completely tax-free.

For instance, say your total income for a financial year comes up to Rs. 1,40,000. And in addition to this, you earn an income of Rs. 20,000 under a head that is tax-free. In this case, your total taxable income will continue to be just Rs. 1,40,000 (and not Rs. 1,60,000), because that extra Rs. 20,000 is exempt from tax.

Tax deduction vs. tax exemption: Some examples


Tax deduction

Some examples of tax deductions include:

  • Specific investments under section 80C, like Public Provident Fund, National Savings Certificate, and premium for life insurance
  • Payment of health insurance premium under section 80D
  • Specified donations made under section 80G
  • Interest received on the amount in your savings account, as per section 80TTA

Tax exemption

Some examples of tax exemptions include:

  • House Rent Allowance (HRA)
  • Leave Travel Allowance (LTA)
  • Agricultural income
  • Long -term capital gains on equity funds, up to Rs. 1 lakh

So, see how tax deductions are different from tax exemptions? Both these provisions give you tax benefits. They just do it in different ways. Knowing this helps you make more informed decisions during tax planning and investment planning.

Read next: WHY LIFE INSURANCE IS MORE TAX-EFFICIENT THAN OTHER INVESTMENT OPTIONS

Speaking of tax deductions and tax exemptions, did you know that life insurance checks both these boxes? We have a blog on this, so you can get all the details you need.

Read it here

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1Tax benefits are subject to changes in tax laws. Please consult your financial advisor for more details.
ABSLI Child’s Future Assured Plan (UIN: 109N124V01) is a non-linked non-participating individual life insurance savings plan.
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