What is Hindu Undivided Family (HUF)?           

Hindu Undivided Family, or HUF for short, is a joint family structure in which each member of the family is treated as a distinct legal person for tax purposes. Generally speaking, a HUF is created if the family has any gifts, ancestral property, property acquired through the sale of joint family property, etc. Only those who share a common ancestor, their spouses, and their offspring are included. According to section 2(31) of the Income-tax Act, 1961 (henceforth referred to as “the Act”), a Hindu Undivided Family (or “HUF”) is considered a (“person”). According to the Act, HUF is a distinct entity for assessment purposes.

How to plan your finances with HUF (Hindu Undivided Family)

Hindu Undivided Family (HUF) is a significant tax planning tool in India, allowing families to optimize their tax liabilities by treating the family as a separate taxable entity. Here are several ways HUF can be utilized for effective tax planning.

Tax Benefit of HUF

1. Separate PAN and Basic Exemption: HUF has its own Permanent Account Number (PAN) and can avail the basic exemption limit of ₹2.5 lakh, effectively doubling the tax-free income for families with individual PANs as well.
2. Ownership of Multiple Properties: While individuals can only claim one self-occupied property for tax purposes, an HUF can own multiple residential properties without incurring additional taxes on them
3. Income Splitting: Individuals can assess part of their income under their personal PAN and another part under the HUF PAN. This allows for claiming the basic exemption limit twice, thereby reducing overall tax liability.
4. Investment Deductions: HUF can invest in various tax-saving instruments such as life insurance, Public Provident Fund (PPF), and Equity Linked Savings Scheme (ELSS), claiming deductions up to ₹1.5 lakh under Section 80C for these investments.
5. Tax-Free Gifts: Gifts received by an HUF are tax-free up to ₹50,000, and larger gifts can also be structured to avoid taxation if properly designated.
6. Health Insurance Deductions: An HUF can claim deductions on health insurance premiums paid for its members, providing an additional deduction of ₹25,000 under Section 80D, which can be combined with individual claims for greater benefits.
7. Ownership of Multiple Properties: While individuals can only claim one self-occupied property for tax purposes, an HUF can own multiple residential properties without incurring additional taxes on them

Example

Consider a scenario where an individual has a taxable salary of ₹20 lakh and receives ₹9 lakh from rental income. By transferring the rental property to an HUF, the taxable income could be reduced significantly, resulting in substantial tax savings due to the separate assessment of the HUF’s income.

Consider a scenario where an individual has a taxable salary of ₹20 lakh and receives ₹9 lakh from rental income. By transferring the rental property to an HUF, the taxable income could be reduced significantly, resulting in substantial tax savings due to the separate assessment of the HUF’s income.

Disadvantages of HUF

Hindu Undivided Family (HUF) has several disadvantages that individuals should be aware of before forming one. Here are the key drawbacks:

1. Equal Rights on Assets: Each member of the HUF has equal rights to the family assets, which can lead to complications during asset distribution or when unanimous consent is required for decisions, such as selling property.
2. Unlimited Liability of Karta: The Karta, or head of the family, has unlimited liability for the debts of the HUF. This means personal assets of the Karta can be used to settle business debts, posing a significant financial risk.
3. Limited Flexibility: The structure of an HUF is less flexible compared to other business entities, such as partnerships or companies, making it harder to adapt to changing circumstances.
4. Partition: Shutting down a HUF is possibly the biggest nightmare of starting one. A partition is the sole way to dissolve a HUF. Dissolving the HUF requires the consent of all members. Assets are divided among members under a partition, which can cause many disagreements and legal issues.
5. Joint family system losing relevance: The joint family arrangement is becoming less relevant because the income tax department recognized HUF as a distinct taxable entity. However, HUF is becoming less relevant in the modern era, since nuclear households are the norm. Numerous instances of couples or families arguing over shared household expenses—not to mention the pool of assets have come to light. HUF as a tax vehicle is becoming less significant as divorce rates rise.
6. HUF continues to be assessed as such till partition: Unless a partition occurs, you must keep filing the HUF’s tax returns once it is established. Any partition claim is submitted to the evaluating officer. After providing the members with adequate notice, the assessing officer is required to conduct an investigation upon receiving such a claim. The member’s individual income is taxed on the income from the divided property. The revenue from the property transferred from the original HUF is taxed in the new HUF if the member creates a new one with his wife and kids.