Surprising — how Tax on FD and Bank Accounts reduces your returns

We have often heard that putting our money in banks is a safe way to get fixed returns. Few of us realize that interest generated on savings accounts and fixed deposits is taxable and needs to be declared in annual tax statements. Let us see how these this interest income is taxed.

Fixed Deposits

Interest earned from Bank FD and Recurring Deposits (RD) is taxed at an individual’s marginal income tax slab rate. For example, a person with an annual income of more than 10 lakh will be liable to pay 30% income tax on FD interest accrued every year.

Tax Deducted at Source (TDS)

Banks are also required to cut ‘Tax Deducted at Source’ or (TDS) on interest accrued from your fixed deposit. The purpose of TDS is to ease the process of tax collection and the following rates apply:

The interest on fixed deposits is taxed based on the individual’s tax slab. This means that if you fall in the 20% or 30% tax slab, you will have to pay extra tax in addition to the TDS charged by the bank. In case your income is less than 2.5 lakhs, you can submit Form 15G to the bank which prevents them from deducting TDS on FD interest. While 15G is for those who are lower than 60 years of age, Form 15H can be used by senior citizens.

Example 1:

Rohit has invested ₹10 lakh in a 2 year Bank FD at 6.00% interest rate on April 1 2016. His annual income in 2016–17 was more than ₹10 lakh. He earned ₹60,000 as interest in FY 2016–17. Thus, he is liable to pay income tax at 30% on ₹60,000 equalling ₹18,000. The bank reduces ₹6,000 as TDS while Rohit needs to pay additional ₹12,000 as income tax. This tax reduces his net interest income to ₹42,000 for the year. His effective rate of return becomes 4.2%.

Tax on FD Interest Payable on Accrual Basis

An important thing to note is that the income tax on FDs applies on an accrual basis. This means that irrespective of the term of the FD, income tax needs to be paid every year on the interest accrued (earned) in that year. In the above example, Rohit would need to pay income tax of ₹12,000 in the 1st year from his own pocket since his FD term was 2 years. The bank would pay ₹6,000 as TDS thus reducing the amount to be compounded for 2nd year by ₹6,000.

Taxation on Savings Accounts

Savings accounts typically earn interest between 3.5% – 4%. This interest earned through savings accounts is also subject to income tax at the individual’s marginal income tax rate. However, the government has exempted a total interest up to ₹10,000 across savings accounts from income tax. Nevertheless, this needs to be declared on the tax return.

Misconceptions on How to Reduce Your Tax

While there are some instances where you can be exempt from tax, the following do not apply.

· Investing through a non-working spouse or minor bank account will still attract tax based on your tax slab.

· Setting up accounts in different branches of the same bank won’t reduce TDS as banks aggregate interest income across all branches.

Are There Any Tax Exemptions for Bank Accounts?

Yes! There are ways in which you can save up using the following methods:

In a savings account, a maximum of ₹10,000 per year is exempted from income tax under section 80TTA. This can only be done when you declare your interest income under the head ‘income from other sources’. Any additional amount is taxable. For example, if you have made 17,000 rupees from the interest, only 7,000 rupees is taxable. Please make a note that this is possible only if you are an individual or Hindu undivided family.

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