Income tax is an essential aspect of personal finance, directly affecting every salaried employee, business owner, and self-employed individual in India. Knowing how income tax is calculated helps you plan your finances better and make the most of deductions available under the tax laws. Income tax is a tax levied by the government on an individual’s earnings, calculated based on income earned over a financial year. The Income Tax Department of India has structured the tax system to include both an old tax regime (with deductions and exemptions) and a new tax regime (with lower rates and fewer exemptions), allowing taxpayers to choose whichever suits them best.
In this blog, we’ll break down the process of calculating income tax, and explain how to optimize your tax liability.
Before diving into how income tax is calculated, it’s essential to understand the two main types of income tax rates applicable in India: slab rates and flat rates.
Income Tax Calculation Basics
The Income Tax Act, 1961, categorizes income into five heads:
1. Salary Income :
Earnings from salary and pension.
2. House Property Income :
Income generated from renting out a property.
3. Capital Gains :
Profits from the sale of capital assets, like property or stocks.
4. Business and Profession Income :
Income from business or professional services.
5. Other Sources :
Any income that does not fall under the above categories, such as interest from savings accounts, dividends, etc.
Each type of income has unique rules for taxation and deductions. When calculating tax, it is crucial to add up income from all sources to arrive at your gross total income.
Step-by-Step Guide on How Income Tax is Calculated
1. Calculate Gross Total Income
To determine how income tax is calculated, start with your gross total income. Here’s how you can calculate it:
- Income from Salary : Includes your basic salary, allowances, bonuses, and any perquisites. Some allowances like transport and house rent allowances may be partially or fully exempt.
- Income from House Property : If you earn rental income, calculate it after deducting standard deductions (like 30% of the rental income for maintenance).
- Income from Capital Gains : This income is taxed differently depending on whether the gains are short-term or long-term.
- Income from Business and Profession : This income is taxable after deducting business-related expenses.
- Other Income : Add any other income sources, like bank interest or dividends.
2. Deduct Allowable Deductions (Under Old Tax Regime)
In the old tax regime, you can claim various deductions to reduce your taxable income. Here are some common deductions:
- Section 80C : Deduction of up to ₹1.5 lakh for investments like EPF, PPF, and life insurance.
- Section 80D : Deduction for health insurance premiums (up to ₹25,000 for individuals and ₹50,000 for senior citizens).
- Section 24 : Deduction for home loan interest (up to ₹2 lakh for self-occupied property).
- Standard Deduction : A flat deduction of ₹50,000-75,000 for salaried individuals and pensioners.
Deductions lower the gross total income to arrive at the net taxable income.
3. Apply Income Tax Slab Rates
The Income Tax Department has set slab rates for both the old and new tax regimes. Let’s look at the tax rates applicable for FY 2024-25:
Old Tax Regime Slabs
- Up to ₹2.5 lakh : No tax
- ₹2.5 lakh – ₹5 lakh : 5%
- ₹5 lakh – ₹10 lakh : 20%
- Above ₹10 lakh : 30%
New Tax Regime Slabs
- Up to ₹2.5 lakh : No tax
- ₹2.5 lakh – ₹5 lakh : 5%
- ₹5 lakh – ₹7.5 lakh : 10%
- ₹7.5 lakh – ₹10 lakh : 15%
- ₹10 lakh – ₹12.5 lakh : 20%
- ₹12.5 lakh – ₹15 lakh : 25%
- Above ₹15 lakh : 30%
In the new tax regime, fewer deductions are available, but you benefit from lower tax rates. Both salaried employees and business owners can choose between the two regimes annually.
4. Calculate Tax Payable
Once you know your net taxable income, apply the applicable slab rates. For example:
- If your income is ₹7 lakh and you choose the new tax regime, the calculation would be:
- ₹2.5 lakh to ₹5 lakh = 5% of ₹2.5 lakh = ₹12,500
- ₹5 lakh to ₹7 lakh = 10% of ₹2 lakh = ₹20,000
- Total Tax Payable : ₹32,500
5. Subtract Rebate and Tax Credits
Under Section 87A, taxpayers with income up to ₹5 lakh qualify for a rebate, reducing their tax liability to zero.
6. Add Health and Education Cess
A cess of 4% is added to the tax payable amount for health and education purposes. This amount is calculated after accounting for deductions, slab rates, and rebates.
Choosing Between Old and New Tax Regimes
When deciding which regime to opt for, consider your income, tax deductions, and financial goals:
- Old Tax Regime : If you have significant investments and expenses (such as a home loan), the old tax regime may be more beneficial due to the deductions available.
- New Tax Regime : Ideal for those who want simpler tax calculations and have minimal deductions.
Tax Filing Process for Calculating and Filing Income Tax
To file taxes and ensure accurate calculations:
- Use an Income Tax Calculator : Online aggregators provide updated calculators.
- Verify with Form 16 : Your employer issues Form 16, summarizing your income and TDS.
- File Online : Use the [e-filing portal](https://www.incometax.gov.in) or third-party portals for quick and secure filing.
FAQs
1. Can I switch between tax regimes each year?
Yes, salaried individuals can switch regimes annually, while businesses must choose once and follow it consistently.
2. What happens if I don’t pay the calculated tax?
Non-payment of taxes leads to penalties and interest, as per the Income Tax Act. Ensure timely payment to avoid additional costs.
3. Can I claim deductions in the new tax regime?
The new tax regime allows only a few deductions, including the standard deduction of ₹50,000, making it essential to assess which regime is more beneficial.
4. Do I need to pay tax if my income is below ₹2.5 lakh?
No, individuals with income below ₹2.5 lakh are exempt from tax under both regimes.
5. How can I reduce my tax liability effectively?
Consider maximizing deductions if opting for the old regime or assessing investment options that offer tax benefits, such as ELSS and NPS, for tax optimization.
Conclusion:
Understanding how income tax is calculated empowers you to manage your finances better and make informed decisions about investments and savings. Whether you choose the old tax regime with its numerous deductions or the simplified new tax regime, staying informed on current rules and using reliable tax portals online will streamline the process.
With regular updates to tax policies, keeping track of changes in income tax rates, deduction rules, and filing procedures ensures compliance and better financial health.
