How is income tax calculated?

Tax time is here again. Several taxpayers will be e-filing tax returns on their own. While filing your returns, a question is likely to cross your mind about how your tax dues are calculated? It’s important to understand this calculation, so you can review your return and check whether tax is due from you or a refund shall be paid to you.

Income tax is payable when your income exceeds Rs 2.5lakhs. Income is aggregated from all sources. And deductions under section 80 of the income tax act are allowed from such aggregate income. Your income tax return cannot be successfully submitted unless tax has been duly paid.

If you are salaried most of your tax dues are taken care of via TDS or tax deducted at source by your employer. However, if you have earned interest income or any other income such as rent or capital gains, you’ll have to calculate tax yourself. The most important thing to remember while calculating your taxes is to always calculate it on your aggregate income. Say for example you want to calculate and pay tax on rental income earned by you. To compute tax on such income, you must recalculate your total income and then calculate tax payable on it. Even though TDS has been deducted on your salary, total income including salary has to be recomputed. Once total tax is calculated any TDS which has already been deducted is adjusted from it and remaining dues have to paid.

Let us understand tax computation in detail.

Income is categorised under five heads, income from salary, income from house property, income from capital gains, income from business and profession and income from other sources. If any exemptions or deductions are available specific to these heads those are allowed before calculating aggregate income. For example, HRA exemption, LTA exemption are allowed on salary income first and then salary income is included in total income. Similarly, on rental income, deduction is allowed for municipal taxes and 30% as standard deduction. After these deductions, rental income is included in aggregate income. If you are a freelancer, expenses directly related to your freelancing work can be reduced from your freelancing income before such income is included in your total income under the head business & profession. Once you have arrived at your total income from all heads, you can reduce deductions available under section 80. Deduction for EPF, PPF investments, LIC premium are allowed under section 80C. Deduction from medical insurance can be claimed under section 80D. Total income less deductions gives your total taxable income. Now calculate tax on this income. Rs 2.5lakhs of this total taxable income is exempt. On the remaining income up to Rs 5lakhs tax is calculated @ 10% and tax of 20% is applicable on income from Rs 5lakhs to Rs 10lakhs. Any income above Rs 10lakhs is charged @ 30%. On such total tax, cess is calculated @ 3% and must be paid along with tax. Any TDS which is already deducted on salary or interest is reduced from total tax. Remember to include the income related to TDS which you will be adjusting from your total tax.

Let’s understand income tax calculation by way of an example. Neha receives a Basic Salary of Rs 50,000 per month. HRA of Rs 25,000. Transport Allowance of Rs 8,000 per month. Special Allowance of Rs 5,000 per month. LTA of Rs 20,000 annually. Neha pays a rent of Rs 20,000 and lives in Delhi. Neha has income from interest from savings account of Rs 8,400 and a fixed deposit interest income of Rs 5,500 during the year. Neha has made some investments to save income tax. PPF investment of Rs 50,000. ELSS purchase of Rs 20,000 during the year. LIC premium of Rs 8,000. Medical insurance paid of Rs 12,000. Neha’s employer deduction Rs 50,000 as TDS.

Neha’s total income from salary works out to Rs 8,64,800.

Basic Salary Rs 6,00,000

HRA Rs 1,20,000 (Rs 3,00,000 less exemption Rs 1,80,000)

Transport Allowance Rs 76,800 (Rs 96,000 less exemption Rs 19,200)

Special Allowance Rs 60,000

LTA Rs 8,000 (Rs 20,000 less bills submitted 12,000)

 

Deductions claimed

Section 80C Rs 1,50,000 (PPF deposit Rs 50,000, ELSS investment Rs 20,000, LIC premium Rs 8,000. EPF deducted by employer (Neha’s contribution) = Rs 50,000 *12% *12 = 72,000)

Section 80D Rs 12,000 (Medical insurance Rs 12,000)

Section 80TTA Rs 8,400

 

Income from salary Rs 8,64,800

Income from interest Rs 18,400

Gross total income Rs 8,83,200

Less deductions Rs 1,70,400

Gross taxable income Rs 7,12,800

 

Tax calculation

Up to Rs 2,50,000                         Exempt from tax                                                        0

Rs 2,50,000 to Rs 5,00,000          10% (10% of Rs 5,00,000 less Rs 2,50,000)              25,000

Rs 5,00,000 to Rs 10,00,000        20% ( 20% of Rs 7,12,800 less Rs 5,00,000)              42,560

More than Rs Rs 10,00,000         30% (nil)                                                                      0

 

Cess      3% of total tax (3% of Rs 25,000 + Rs 42,560)      2,026

 

Total Income Tax            Rs 25,000 + Rs 42,560 + 2,026    Rs 69,586.80

 

Total tax payable by Neha is Rs 69,586.80 of which Rs 50,000 has already been deducted as TDS and remaining Rs 19,586.80 must be paid by Neha before filing her tax return.

 

This article was published by ClearTax on Yahoo! Finance on 13th July 2016.

2 Responses to How is income tax calculated?

  1. sasibhusan Patnaik July 21, 2016 at 8:37 pm #

    Car loan is
    Under it returns

    • cleartax-team July 22, 2016 at 10:02 am #

      Sir, the treatment of car loan depends upon your nature of income, which ITR you are filing also it may have to be disclosed in Schedule AL if your total income exceeds Rs 50lakhs. If you need help with your tax returns, you can drop us an email support@cleartax.in. You can also consider taking CA asssistance, where a CA will prepare and e-file your tax return.