BQ Explains: All You Need To Know About Personal Income Tax

This simple guide will tell you how tax is calculated and how to reduce your tax outgo. 

Source: BloombergQuint
Source: BloombergQuint

Income tax is the money that the government collects from individuals to fund its various expenses. The amount of tax you pay depends on which income tax slab you fall under, and therefore, on how much you earn. Simply put, the higher the income, more the tax.

  • If you earn up to Rs 2.5 lakh in a year, you pay zero tax.
  • Income between Rs 2.5-5 lakh is taxed at 5 percent.
  • Income above Rs 5 lakh and up to Rs 10 lakh gets taxed at 20 percent.
  • All income above Rs 10 lakh attracts a 30 percent tax.

The tax rates apply on an individual’s “taxable income”. You can minimise your taxable income, that is the amount on which you pay tax, by applying various deductions that are provided in multiple sections of the Income Tax Act. But before we get to the deductions, here’s a simple explainer on how the income tax is calculated.

There is often confusion when it comes to the method of calculating the amount of tax an individual pays. People assume that if they fall in a certain tax bracket—say the Rs 5-10 lakh bracket—they pay the applicable tax on their entire income. This is a common misconception.

Here’s how it actually works: Suppose an individual’s taxable income stands at Rs 9 lakh. The tax payable on the first Rs 2.5 lakh of this is zero. In other words, this amount is non-taxable. On the amount between Rs 2.5 lakh and Rs 5 lakh, the individual pays 5 percent tax—Rs 12,500. And finally, on the earnings above Rs 5 lakh and below Rs 10 lakh, in this case Rs 4 lakh, the individual pays 20 percent tax—Rs 80,000.

So, in this illustration, the individual pays a tax of Rs 92,500. If the 20 percent tax rate was applicable on the entire Rs 9 lakh, the total tax payout would have been Rs 1.8 lakh.

Minimise Your Taxable Income!

There are many ways for individuals to bring down their tax outgo. These are through deductions that are enumerated under the sections of the Income Tax Act. Effective planning of investments can ensure that taxable income is reduced.

Here are some of the broad categories:

Section 80C

Most salaried individuals make use of Section 80C of the Income Tax Act to make basic tax-saving investments. The total deduction to taxable income available under this section is Rs 1.5 lakh.

The first thing you can do is check your contribution to the employees’ provident fund. This is deducted by your employer from your taxable income.

Additionally, under Section 80C, you get deduction on the payment towards principal amount in a home loan’s equated monthly installment. But this will be included under the Rs 1.5 lakh limit.

BQ Explains: All You Need To Know About Personal Income Tax

Other Avenues

Another Rs 50,000 can be saved by investing in the National Pension Scheme under Section 80CCD of the Income Tax Act. Note: You can claim deductions over and above this under the broad limits of Section 80C.

Under Section 80D, you can take a health insurance cover for yourself and a premium of up to Rs 25,000 is deductible from your taxable income. Additionally, if you have senior citizens at home, you can buy health insurance policies for them and avail of a further deduction of up to Rs 50,000 for the premium paid.

If your salary does not include a provision for house rent allowance, Section 80GG allows you to reduce up to Rs 60,000 from your taxable income.

BQ Explains: All You Need To Know About Personal Income Tax

Education loans are sometimes a drag, but Section 80E of the Income Tax Act lets you deduct the entire interest paid during a year from your taxable income for your own higher education, or that of your spouse or children. This benefit is available for eight years starting from the year you start repaying the loan, or till the interest is fully repaid.

As part of its bid to encourage home ownership, the government provides benefits to first-time home buyers under Section 24 of the Income Tax Act. Interest payments on a housing loan to the extent of Rs 2 lakh can be reduced from the taxable income. And the best part is that your spouse is also eligible for a similar deduction, so the total benefit afforded is Rs 4 lakh towards payment of the interest portion of your housing loan EMI.

Finally, the interest you earn from your savings bank account up to Rs 10,000 is also deductible from your taxable income.

Senior citizens have some added advantages that were introduced in Budget 2018. Firstly, there is no tax applicable on interest worth Rs 50,000 that is earned on fixed deposits. Second, the deduction under Section 80D for the mediclaim premium paid for senior citizens was raised from Rs 30,000 to Rs 50,000.

Lastly, you’ll notice that from this year, instead of a separate allowance for medical expenses and transport, a standard deduction of Rs 40,000 has been introduced for salaried individuals.