Confused with income tax terminologies & tax rates: a primer

This is a blog to help the first-timers to understand the basic income tax terminology when they start working. Also, we provide you steps to check which tax regime is better – the old tax regime or the new tax regime?

It can be overwhelming especially in the first one year of working when we are excited to get our first salary. But at the same time, in the salary slip, there could be an amount under the tax deducted at source (TDS) which could make us sad as that is an outgo from our income. I would like to mention that paying income tax is not bad. There are two ways in which our Government gets revenue for the country’s development – Direct taxes and Indirect taxes.

Income taxes is one of the Direct tax options. But, taxes can be saved legitimately.  The terms “tax  ” and “tax evasion” are often used interchangeably, but they are very different concepts. Tax avoidance is legal, while tax evasion is not. We will get into the details of how to avoid taxes, but broadly the concept is avoiding it through by availing tax exemptions and investing to save taxes. The Government provides tax benefits to people to encourage them to save so that in their old age, they do not get dependent on the Government for survival and subsidies. There is a thin line between getting people to spend now (and thus boost up the economy), versus encouraging them to save for later use (thus deferring the spending).

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Income tax terminology

Let’s understand some of the basic terms which appear in your salary slip or Form 16.

1. Gross income

It is the total earning, before claiming any deduction or exemptions. Gross income includes not only your salaried income but the income you earn from various other sources like interest, dividend, capital gains, etc.

2. Heads of Income

For income tax purposes, income is classified as under 5 heads. While filing income tax returns, which form to be used would also depend on what sources of income need to be declared. All the heads are self-explanatory. The tax rates vary depending on the type of income head.

  • Income from salary
  • Income from house property
  • Income from profit or gains from business
  • Income from Capital Gains
  • Income from other sources: – gift, prize, lottery

3. Tax Exemptions

As mentioned earlier, not entire income which is earned is subject to taxes. There are certain exemptions that are provided which helps in reducing the tax liability.

  • Standard Deduction: A flat standard deduction of Rs 50,000 per year is provided to everyone
    • HRA (house rent allowance): Minimum of the following HRA is exempt from tax –
      • Actual HRA received
      • 50% of annual salary* if living in metro cities or else 40%
      • Actual Rent paid less 10% of Basic + DA
      • Children Education Allowance + Hostel Allowance
      • LTA (Leave travel allowance): Twice in a block of 4 years. Up to the amount specified in the offered letters. This is provided against submission of receipts and is available only for domestic travel tickets and not for hotel stay.
Tax exemption
  • Section
  • 80 C
  • 80 CCC
  • What?
  • ELSS, PPF, NSC, Principal loan, Tuition fees, Insurance, ULIP, Sukanya Samriddhi, etc.

  • Pension Policy
  • Amount & criteria
  • Cap of Rs 150,000

  • Max deduction is under section 80 C itself

4Tax Deductions

Income tax rules also provide for tax deductions under various types of investments. A summary of deductions available under various sections is provided below:

SectionWhat?Amount & criteria
80 CELSS, PPF, NSC, Principal loan, Tuition fees, Insurance, ULIP, Sukanya Samriddhi, etc.Cap of Rs 150,000
80 CCCPension PolicyMax deduction is under section 80 C itself
80 CCD (1)National Pension SchemeMax 10% of salary or total income up to Rs 150,000, under 80 C limit
80 CCD (2)Additional contribution to NPSRs 50,000
80 DMedical insurance –self & family; parentsRs 25,000 (Rs 50,000 in case of sr. citizens); Additional for parents;

Rs 5,000 for preventive health check up

80 DDMedical expenditure –handicapped dependent relative40 to 80% disability: Rs 75,000 fixed

> 80% disability: Rs 125,000 fixed

80 DDBMedical expenditure –self, dependentSpecified ailment or disease; Amount incurred up to Rs 40,000 (Rs 60,00 for sr. citizen and Rs80,00 for very sr. citizen)
80 EEducation loan for higher studies -Self, spouse, children, legal dependentsInterest up to max of 8 years
80 EEAdditional Housing loan benefitsSanction in 2016-17, Loan < Rs 35 lakhs and property less than Rs 50 lakhs, No other residential property owned
80 GDonations for social causes100% or 50% with or without restriction. In cash > Rs 2,000 disallowed. Max allowed up to 10% of income
80 GGRent where HRA is not paidMin: Rent paid minus 10% income; Rs 5,000 pm; 25% of total income
80 GGCContribution to political partiesOther than cash, certain restrictions, else there is no limit
80 RRBIncome: Royalty of PatentLower of Rs 300,000 or income received
80 TTAInterest on Saving Bank AccountInterest above Rs 10,000 p.a. taxable
80 UPhysical disability of dependentRs75,000. In case of severe disability, Rs 125,000
10 13 (A)House Rental AllowanceMin: HRA, Rent minus 10% Basic, 40% or 50% (Metro) of Basic
24Housing Loan InterestUp to Rs 2 lakhs. If a property is not occupied within 5 years of loan sanction date, the benefit is restricted to Rs 30,000

5. Taxable income

This is the income after the exemptions and deductions have been subtracted from the Gross Income. Tax is paid on the taxable income and not on the Gross income. There is something called “Exemptions” and “Deductions” which are reduced from your income to arrive at “Taxable Income”. 

6. Tax Deducted At Source (TDS)

Based on the proposed investments planned by the employee in the financial year (generally submitted at the beginning of the financial year), the employers start deducting tax at source (TDS) for the remaining taxes due for the year every month. The investment proofs for the declared investments are generally called for by the employer in Jan or February of the financial year. If they are submitted tax proofs are for the lower amount than the plan, then remaining taxes that are due are deducted as TDS before the end of the financial year. However, if TDS is more than what is due, then the employee can claim the refund while filing the income taxes. Please do note that if any taxes are due for any income other than salary, then they should be calculated ourselves, and advance taxes should be paid on or before the respective due dates to avoid any penalty and interest while filing taxes. At any point in time, you can check all TDS which has been deducted in form 26AS which can be downloaded from TRACES website.

Income tax structures

The Budget announced in February 2020, made some radical changes to the income tax structures. It has given an option to the assessees to choose whether they want to continue with the previous tax regime (with tax benefits but higher tax rate) or new tax regime (with no tax benefits but lower tax rate). This is to provide an option for people who would like to spend now (and not save for the future) and therefore have more money in hand, which could also provide an impetus to the economy.

A comparison of the two structures is provided below:

Existing & New Tax Structure

Earlier tax regimeAnnual IncomeNew tax regime
NilUp to Rs 2.5 lakhsNil
5%Rs 2.5 lakhs to Rs 5 lakhs5%
20%Rs 5 lakhs to Rs 7.5 lakhs10%
Rs 7.5 lakhs to Rs 10 lakhs15%
30%Rs 10 lakhs to Rs 12.5 lakhs20%
Rs 12.5 lakhs to Rs 15 lakhs25%
Above Rs 15 lakhs30%

In addition:

Health & educational cess: 4%

Surcharge: Income Rs 50 lakhs to Rs 1 crore: 10%

      Income Rs 1 crore to Rs 2 crores: 15%

      Income Rs 2 crores to Rs 5 crores: 25%

      Income > Rs 5 crores: 37%

In new tax regime, some of the 70 exemptions and deductions would not be available

Zero tax even if income is up to almost Rs 10 lakhs

Yes! If you plan it well, you can get your income taxes to zero. Besides, in Budget 2019 there was an announcement that if the net taxable income (after claiming exemptions and tax deductions) is less than Rs 5 lakhs, then the taxes due are subject to a rebate under Section 87A, thereby no taxable income for the assessee. However, if it exceeds by even Re 1, then the entire amount would be subject to taxes and this rebate will not be available. So, do check out various deductions given earlier in a table and see which are the ones applicable to you. Proper tax planning can save money, legitimately!

Which Tax regime is better?

Government proposes to provide a choice to tax payers: savers or spenders

  • For those who are spenders, lower tax rates are being proposed. Hopefully, the money saved through lower tax rate would fuel consumption which would help the country
  • For those who claim the tax exemptions regularly, they could be better off by continuing the same, since even though tax rate could be higher, the net taxable income after exemptions could be much lower and therefore lower taxes.
  • Government’s long-term view is that eventually tax deductions and the exemption would be withdrawn and tax structure simplified
  • “Spend now –save later” mindset could be injurious to financial health. We are in a country where social security is practically non-existent

Comparison between Old and New tax regime

https://www.incometaxindiaefiling.gov.in/Tax_Calculator/index.html?lang=eng

When should tax planning be done?

Planning of taxes should be planned at the beginning of every financial year and not towards the end. There are several advantages:

  • Easy on Pocket: You can plan your monthly investments for various tax deductions and therefore don’t need to shell out a large amount of money at the end of the financial year when tax investment proofs are called for.
  • Lesser mis-selling: A lot of mis-selling starts happening in December or January of every year when there is a pressure on employees to submit investment proofs to claim the tax deduction. Long term investments which may not be the best could be done succumbing to the pressure, which can be avoided if planned well in advance.

So, I hope this primer on tax planning was useful to you in understanding some of the terminologies and ways in which taxes could be saved. Remember taxes should be avoided and not evaded! If you have any questions, please feel free to comment below or contact me. If you would like to read more personal finance blogs, then you could check out my website or my YouTube channel for videos on this topic.

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