Income tax 101
Hey folks, as the already delayed filing season is approaching, we thought of blogging about basic concepts of income tax for nonfinance background individuals. Without any BS let’s get started.
What is tax: Tax is a mandatory fee or financial charge levied by the government on individuals or organizations to collect revenue for public work and providing facilities and infrastructure.
What is income: Salary earned from your company plus earnings from side gigs plus interest earned from the bank plus dividends received on stocks plus rent received if you own a house etc gets added up as your income. You can get details of your salary and TDS (Tax deducted at source) from Form 16 provided by your company. Form 16/16A is the certificate of deduction of tax at the source issued by your employer. Let’s say you earn 10L as your salary, 1L from side business, 20k as interest from your FD then your gross income adds up to 10L + 1L + 20k = Rs. 11,20,000 /-
What are deductions: Deduction is a way to reduce your gross income thus reducing your tax liability. You are allowed to claim deduction on money earned i.e you are allowed to not pay tax on an amount equivalent to the amount invested in certain schemes like EPF, PPF, NPS, ELSS, etc, or under other defined sections of income tax. Under section 80C of income tax, you can claim a maximum deduction of 1.5L. Likewise, there are other sections 80CCC — Insurance Premium, 80CCD — NPS Contribution, 80GG — House Rent, 80E — Interest on education loan, etc which you can use to claim an additional deduction. Let’s say you have invested 1.5L in ELSS Scheme under section 80C and paid 70k as your house rent, then you can claim a deduction of Rs. 2,20,000 /-
What is taxable income: Income on which you have to pay a tax post subtracting the deductions.
Taxable Income = Gross income - Deductions
If we consider the numbers from the above scenario where our gross income is 11.2L and deduction is 2.2L then our taxable income comes out to be 9L This is the income you are liable to pay tax on. The question of how much tax to pay is defined in the next section
What are Tax Regime and tax slabs: Tax slabs define the amount of tax one needs to pay on taxable income. You have an option to file your income tax under the Old or New tax regime having different tax slabs
The old regime gives you freedom with deductions which is partially available in the new regime.
Financial Year (FY) vs Assessment Year (AY): The period between 1st April to 31st March where you earn an income is the Financial year, and the year that comes after FY where you pay the tax is Assessment Year. If FY is 1st April 2020 to 31st March 2021, then AY will be 1st April 2021 to 31st March 2022.
Putting all the above concepts together:
Let’s consider a scenario where we calculate taxes for FY 2021–22 and one will pay the below-calculated tax in AY 2022–23.
Income
- April 2021 — You started a Job where you are earning 1L Salary per month(Post deduction of TDS. Know more about it in the next section). So in FY 2021, the income generated from your salary will be 12L
- Feb 2022 — You received an income of 1L for your side gigs
- Mar 2022 — You received rent of 40k on your property
- 2021–22 — You received an interest of 10k from your savings account
- 2021–22 — You had a realized profit of 1L in the stock market
Gross income for FY 21 = 12L + 1L + 40k + 10k + 1L = 14.50L
Deductions
- Under section 80C you make an investment towards tax saver mutual funds of 1.5L
- Under section 80CCD (1b) you invest 50k in NPS
- Under section 80D you claim a deduction of 10k on the purchase of medical insurance
- Standard deduction of 40k for salaried employees (FY 20–21 onwards this is increased to 50k, but we’ll calculate with 40k for simplicity)
Total deductions for FY 21 = 1.5L + 50k + 10k + 40k = 2.5L
Taxable income = 14.50L - 2.5L = 12L
Now 12L will be divided as per tax slabs in Old regime:
- (0–2.5L) First 2.5L out of 12L is taxed at 0%. So 2.5L * 0% = 0
- (2.5L — 5L) Next 2.5L out of 12L is taxed at 5%. So 2.5L * 5% =12500
- (5L — 7.5L) Next 2.5L out of 12L is taxed at 20%. So 2.5L * 20% = 50000
- (7.5L — 10L) Next 2.5L out of 12L is taxed at 20%. So 2.5L * 20% = 50000
- (10L — 12.5L) We are left with 2L which is taxed at 30%. So 2L * 30% = 60000
Total tax to be paid = 12500 + 50000 + 50000 + 60000 = Rs. 1,72,500 /-
So one will have to pay a tax of Rs. 1,72,500 /- on the income earned for the Financial year 2021 in Assessment year 2022.
Let’s talk about TDS in brief:
Tax Deducted At Source (TDS) — As per the income tax rule, your employer will deduct tax while paying you the salary. Form 16A provided by the company has details about TDS deducted by them. Another place where you can find these details is in Form 26A which can be found here. So for salary above 10L, usually TDS of Rs. 1,12,500 + 60000 (30% of income above 10L) = Rs. 1,72,500 /- is deducted by your employer (assuming no declaration was submitted by you with your employer) i.e 1,72,500 / 12 = Rs. 14375 /- per month will be deducted directly from your salary.
So, considering TDS into the picture you don’t have to pay any tax as the TDS deducted is equal to the tax to be paid. Well, this happened coincidently, most of the time you’ll have to pay a small amount of tax if TDS deducted is less compared to tax to be paid, or there can be a scenario where TDS deducted is more compared to the tax which you are expected to pay. In this case, post-filing the ITR(Income tax return) the difference will be refunded.
The total tax to be paid we calculated above will be different if we calculate the above scenario with New tax regime slabs. We’ll cover this in the next part of the blog.
Hope you guys have got a gist of how income tax is calculated on the income earned in a financial year. You can reach out to us on Twitter & LinkedIn for questions, feedback, and advice.
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