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Primer: Income Tax Calculations for Beginners

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When you are starting your professional career, the excitement of getting the first salary credited to your bank account is palpable. However, the difference between expected credit and actual credit can many times leave you puzzled.

The difference is due to income tax. It is correct that you cannot save taxes beyond a point. However, by planning your taxes properly, you can save a lot of money.

In this primer post on personal taxation, I will discuss taxation basics and help you understand how you can calculate your income tax liability. With such knowledge at your disposal, you may be able to plan your taxes in a much better manner.

In fact, my experience suggests that even professionals who have been working for a long time are not comfortable with tax calculations. Such readers may also find this post useful.

Your Total Income consists much more than your Salary

According to the Income Tax Act, the total income of any individual has to be divided into five different heads.

  • Income from Salary (The salary that you receive from your employer)
  • Income from House Property (Rental income from a house or more than one houses given on rent)
  • Income from Business or Profession (If you have any kind of business or profession you are running, then that income will be classified under this head)
  • Income from Capital Gains (If you have sold any capital asset such as a house or a shop or shares, then such income will be classified under this section)
  • Income from Other Sources (Any income not classified in any of the above heads will be classified under this head such as income from interest on savings account, interest on fixed deposits, dividends, gifts etc.)

Any income that you earn will fall under one of the above heads. If you are a salaried employee, it is quite likely that a significant part of your income would fall under the head Income from Salary.

Now, the question is how your income is calculated for taxation purposes?

To put it simply,

Your Taxable Income = Gross Income – Exempt Income – Deductions

how to calculate income tax liability

Deductions and Exemptions (Exempt Income)

Incomes from all the heads are added up and you are allowed to use deductions and exemptions (both are different) before paying the taxes.

Deduction means you are allowed to deduct a specific investment/expense from your total income. Prominent examples are your investments under Section 80C (PPF, life insurance premium) or health insurance premium (Section 80D). Here is a list of a few lesser known income tax deductions.

On the other hand, in case of exemption (exempt income), the amount is not included in the income and straight away exempted. Major examples include a certain portion of HRA or long term capital gains on equity investments.

To contrast between deductions and exempt income, if you receive House Rent Allowance (HRA), a certain amount of HRA calculated is exempt while on the other hand, when you pay health insurance premium, you can get a deduction of up to a certain amount as per the conditions.

Details about HRA calculations are covered later in the post.

In case of HRA, you received something and it will not be included in the income while in case of medical insurance premium, you have paid it from your income and then you have to claim the deduction.

Remember, that anything that you have claimed as an exemption cannot be claimed as a deduction at the same time and vice versa.

Tax Deduction at Source (TDS) and Advance Tax

The provisions of the Income Tax Act are made in such a way that it facilitates the government first and then you. Frankly, nothing wrong with the approach.

That is the reason, you get your salary after the deduction of TDS. In a few cases, TDS deducted may even exceed your actual tax liability. In such cases, you then have to apply for a refund when you file your income tax return.

Similarly, if your tax liability is likely to be more ₹10,000 in a single financial year from sources other than salary, you have to pay advance tax at different intervals throughout the year.

Therefore tax planning has to be done proactively and not at the end of the year when you will be left with limited options and in that case too, it will facilitate the government first and then you.

Now, I am going to describe some simple yet effective ways in which you can easily save taxes, especially if you are a salaried person i.e. you receive your major part of income through salary.

HRA Calculation – Easily Explained

HRA means House Rent Allowance.

If you are a salaried individual and living in a rented house, you can take benefit of HRA as per section 10(13A) of the Income Tax Act.

Here is how HRA exemption is calculated.

  1. Actual amount received from your employer.
  2. 50% of Basic Salary + Dearness Allowance for metro cities. This is reduced to 40% if you are not living in a metro city.
  3. Actual Rent paid less 10% of your basic salary during the year.

After calculating these 3 amounts separately, the amount which is the minimum of the above three is available as HRA exemption.

Let’s take an example for better understanding.

Your basic salary for the whole year is ₹5,00,000 and you are paying a rent of ₹1,20,000 yearly.

You stay in Mumbai (a metro city) and you get HRA of ₹1,50,000 per year.

You can easily find the above details in your payslip. I have used yearly figures but you can multiply the monthly salary figures by 12 to get yearly calculation.

Let’s calculate HRA step by step.

  1. Actual amount of HRA the received from your employer – ₹1,50,000.
  2. 50% of basic salary – ₹5,00,000 x 50% = ₹2,50,000.
  3. Actual Rent Paid minus 10% of your basic salary – ₹1,20,000 – ₹50,000 (₹5,00,000 x 10%) = ₹70,000.

The amount in the 3rd point is minimum and therefore that will be amount available for exemption from your HRA.

So, in this example, you received HRA of ₹1,50,000 for the year but you will get exemption for only ₹70,000. Remaining ₹80,000 will be taxable.

This is how the HRA calculation is done. HRA must be included in your salary in order to get an exemption.  You can also pay rent to your parents for claiming HRA which I have explained later in this post.

Lesser known ways to Save Taxes

lesser know ways to save income tax

I do not claim this to be a holistic list. However, for most of us, tax-saving begins and ends with Section 80C investments. In this post, I will discuss a few lesser known ways.

Medical Insurance Premium – Section 80D

You must be thinking that you have definitely heard about medical insurance premium but hold on with me because there are some points which are rarely discussed.

Firstly, under this section you get a total deduction of up to ₹25,000 for payment of medical insurance premium for yourself, your spouse and your dependent children.

The point which is rarely discussed is about preventive health checkup and you can claim deduction of up to ₹5,000 included in the above limit of ₹25,000.

So, for example, you have taken a medical insurance policy for your family and you are paying premium of ₹15,000 and you have also paid ₹4,000 for a preventive health checkup of your spouse.

In the above case, you will get a deduction of ₹19,000 (₹15,000+₹4,000). A lot of people forget about taking the deduction of preventive health checkup of ₹4,000 because they are not aware of it.

If you pay medical insurance premium of your parents and they are senior citizens, you can take a further deduction of up to ₹30,000.

Similarly, you can also avail a deduction for preventive health checkup of your parents up to ₹5,000 but note that it will be included in the above limit of ₹30,000

The point here to note is that many people just forget to avail the deduction of preventive health checkup even though they have paid less amount on medical insurance premium.

Another important point which a very few people know is deduction of medical expenditure of ₹30,000 of your parents even if they don’t have any kind of medical insurance if they are above the age of 80.

This is a benefit because at that age, many people might not have medical insurance but there are high chances that they are incurring medical expenditure.

If there is medical insurance, then no deduction for medical expenditure will be available.

If we consider above example, and assuming you are not a senior citizen (above age of 60), you can easily get benefits of up to ₹25,000 + ₹30,000 = ₹55,000 under this section assuming your parents are senior citizens.

Let’s move on to another way in which you can save taxes.

Deduction of Rent Paid – Section 80GG

This is another section and way that a very few people know about.

Imagine that you are a salaried person and you are paying rent but you do not get HRA (because if it is not the part of your salary), you cannot claim it for HRA tax exemption.

Or, you are a self-employed individual who is living in a rental accommodation. In this case too, you will not get the benefit of HRA exemption.

But, you can claim deduction under this section for payment made towards rent up to ₹5,000 per month.

There is one simple condition to this section that neither you, your spouse or your minor children should not own a residential accommodation where you are living and you must not own any other self-occupied property at any other place either.

Therefore, the maximum deduction you can avail under this section is ₹60,000 per financial year.

Paying Rent to your Parents

You might think, why should I pay rent to my parents? You can save taxes in this way and the money remains in your home like we say, “ghar ka paisa ghar me hi rahega”.

In India, even after growing up, we stay with our parents which is a beautiful way to live life and imagine you can save taxes because of this. Isn’t it a cherry on the cake?

If you are living in a home owned by your parents, you can pay rent to your parents.

As per Income Tax Act, you are paying rent and it does not matter to whom you are paying the rent. The only exception is when you pay rent to your spouse. Rent to your spouse is not taken kindly by the Income Tax Authorities.

You can easily avail HRA exemption as you are paying rent and on the other hand, your parents can also avail standard deduction of 30% as for them it is an income from house property.

Let me give you an example.

Assuming you are in 30% tax bracket and your parents are in 10% tax bracket. Now consider you pay rent to your parents of ₹2,00,000.

But your parents don’t pay taxes directly on the whole amount of ₹2,00,000. They can claim 30% tax deduction under section 24 of the Income Tax Act.

Now, let’s say your parents fall in 10% tax bracket. Your parents will have to pay taxes on ₹1,40,000 at the rate of 10% which comes to ₹14,000 only because of 30% deduction under section 24.

Total tax saved here is ₹60,000 (₹2,00,000 x 30%) – ₹14,000 = ₹46,000.

And how you saved your taxes? By paying rent to your parents. isn’t this amazing?

Let’s now talk about saving your taxes on your money to the tune of ₹2,00,000 straight away.

Taking a Joint Home Loan

If you take a home loan, you will get a deduction of the principal amount under the overall limit of section 80C up to ₹1,50,000.

Apart from that, you can get a deduction under section 24 of the Income Tax Act of up to ₹2,00,000.

Let’s say, you have taken a home loan of ₹45,00,000 and assuming the interest rate is 10%, the EMI roughly comes to ₹5,00,000 a year and in the initial years of a home loan, most of the above would be interest.

Let’s assume you have to pay ₹4,00,000 from the above as interest.

Now, if you have taken a joint home loan with your spouse, both of you can get the benefit of deduction of up to ₹2,00,000 per financial year. That’s twice the tax benefit (as compared to a single borrower loan).

If you were the only borrower, the deduction would have been limited to ₹2,00,000 only.

This way, by taking a joint home loan with your spouse (or any other family member), you can easily save taxes on ₹2,00,000.

These were some ways which are known to a very few people and you can utilize them while calculating your income. But for this, as I said, you have to take a proactive approach and plan your taxes before time as not in the month of March.

Income Tax Slabs for FY 2017-18

Income Tax Slab Rates for FY 2017-18

Additionally, there is a surcharge of 10% of the income tax if your total taxable income is between ₹50 lakhs to ₹1 crore and it increases to 15% of the income tax if your income is above ₹1 crore.

Of course, you will take advantage of basic exemption limit of ₹2,50,000 plus deduction under Section 87A of tax rebate up to ₹5,000 (₹2,500 from FY 2017-18)  if your income is less than ₹5,00,000.

Your Taxable Income = Gross Income – Exempt Income – Deductions

Now, let’s use an illustration to explain how to calculate your income tax liability for the financial year 2017-18. I have assumed that the accounting of income has been done and we have the figures ready for the calculation of salary.

Income Tax Calculation for a Salaried Person for FY 2017-18

Taxable Income from Salary Can be taken from your Form 16 ₹10,00,000
Taxable Income from Other Sources:
Interest on Savings Bank Account ₹5,000
Interest on Bank FD ₹10,000
Income from Dividend ₹500 Exempt u/s 10 (38)

₹15,000

Income from House Property Payment of interest in your self occupied house (value is Nil in self occupied house) (₹2,00,000)
Total Taxable Income from all sources ₹8,15,000
Less: Deductions

(using from the examples above)

Child’s Education Fees, Life Insurance and Principal Repayment of home loan u/s 80C ₹1,50,000
Medical Insurance Premium u/s 80D ₹55,000
Deduction of Bank Interest on Savings Bank Account u/s 80TTA ₹5,000
(₹2,10,000)
Net Taxable Income after all the deductions ₹6,05,000
Tax calculation on your Income From ₹0 to ₹2,50,000 Nil
From ₹2,50,000 to ₹5,00,000 – 5% ₹12,500
From ₹5,00,000 to ₹6,05,000 – 20% ₹21,000
Tax on Total Income ₹33,500
Less:TDS already paid Assuming ₹30,000 is already paid as TDS (₹30,000)
Tax Payable after TDS (Not calculated EC & SHEC) ₹ 3,500

In the above example, you can see you have to pay income tax of only Rs 33,5000on an income of over Rs 10 lacs. The lower tax liability is partly due to inherent tax structure but also due to smart tax planning.

Conclusion

Taxes are a reality and you have to be prepared to deal with them.

If you plan your taxes smartly, you can save a lot of money in a perfectly legal manner.

Your employer will give you Form 16 that will have information about your income and various deductions (based on declarations made by you). In many cases, you can simply use the information to file your returns (many tax-filing portals let you do that). However, if you have income from sources not disclosed to your employer, you may have to stretch yourself a bit to file your returns.

By the way, if you find filing taxes complicated, don’t worry. You can seek professional assistance from a Chartered Accountants or a tax consultant.

Author Bio

This post has been contributed by Rishit Shah, a CA Final student.

Rishit is passionate about finance and taxation and blogs about accounting, Tally and GST at TallySchool.com.

Rishit’s posts have featured in leading tax and personal finance blogs/portals such as

Tally Solutions (company behind Tally), CAClub India, Chartered Club, Tax Guru and Relakhs.com.

You can write to Rishit at rishit@tallyschool.com.

1 thought on “Primer: Income Tax Calculations for Beginners”

  1. A very good written article, it will be supportive to anyone who utilizes it, including me. Keep doing what you are doing – can’t wait to read more posts.

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