How is Income Tax Calculated?

The process of income tax calculation, governed by The Indian Income Tax Act, is vital for financial planning. Despite no changes in tax slabs in the recent interim budget, understanding how income tax is computed is essential for individuals and businesses.

How to Calculate Income Tax?

We will see how to calculate income tax on our salary:

1. First, Calculate Your Gross Salary

   Gross salary refers to your earnings before any deductions are made. It includes:

• Basic salary
• House rent allowance (HRA)
• Other allowances like transport allowance and other special allowances.
• And other perquisites

2. Secondly, Calculate Allowable Deductions

   Now you have calculated the gross salary, it’s time to make deductions. Now, deduct the eligible amounts under various sections of the Income Tax Act. Common deductions included under the income tax are:

• Section 80C: According to sections 80C, investments in ELSS, PPF, NSC, life insurance and premiums, tuition fees, etc., up to ₹1.5 lakh.
• Section 80D: According to section 80D, premiums paid for health insurance for yourself, your spouse and dependent children are up to ₹25,000 (₹50,000 for senior citizens).
• Section 80E: According to section 80E, interest on education loans.
• Section 80TTA: According to section 80TTA, interest earned on savings accounts up to ₹10,000.

3. Thirdly, Compute Taxable Income

   Your taxable income is the difference between your gross salary calculated in step 1 and deductions calculated in step 2. In other words, the amount of salary left with you after deductions is your taxable income.

4. Fourthly, Apply the Applicable Tax Slabs

   For FY 2023-24, the slabs are as follows for individuals below 60 years:

• Up to ₹2.5 lakh: No tax
• ₹2,50,001 to ₹5,00,000: 5%
• ₹5,00,001 to ₹10,00,000: 20%
• Above ₹10,00,000: 30% Additional cess and surcharge may apply for higher income brackets.

5. Fifth, Calculate Tax Payable

   Now it’s time to calculate the amount of tax you should pay.

• One- Identify the tax slab applicable to you.
• Two- Apply the tax rates on your taxable income.
• Three- Then, add cess (4% on the income tax).

6. Sixth, Adjust for Tax Rebates and Relief

   If your taxable income is up to ₹5 lakh, you will be eligible for rebate under section 87A. If you have received arrears of salary, you can also avail relief under section 89.

7. Seventh, Final Calculation

   To know the actual amount of tax payable, deduct any amount you have paid as tax deducted at source (TDS) from the tax payable you calculated above. This will give you:

• You need to pay income tax or
• The refund you will receive.

Conclusion

Understanding how income tax is calculated is essential for managing your finances effectively. Individuals can accurately determine their tax liabilities by following the steps outlined, including deductions for expenses like health insurance premiums and applying the relevant tax rates. Incorporating these considerations ensures a comprehensive approach to financial planning and compliance with tax regulations. Therefore, by grasping the intricacies of income tax calculation, individuals can make informed decisions to optimise their financial well-being and secure their future.

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