Income Tax guide for Beginners

By | April 22, 2024

Most of the investors are not aware of how income tax is calculated and the basic understanding of tax related concepts when they start their career. In this guide, you will learn how to calculate income tax in a very simple and easy to understand way without involving any complicated jargons.

 

What is Income tax?

Income tax is a tax imposed by the government on the income of an individual in every financial year. To calculate your income, all the income sources like salary, business income, rent, dividends, etc are considered. Every citizen of the nation or even a non-residential individual also has to pay this tax to the government if he is earning any income in India.

The govt of any country has various kinds of expenses like paying pension to govt employees, building roads and infrastructure, start various schemes for the citizens benefit etc etc. For all this, they need money and income tax is one of the ways for the govt to earn the money.

The same money eventually is used to run the nation and its development. So when we pay the income tax, we get back various facilities like roads, public parks, and poor people also get various free services in health and education.

Every individual, who has yearly income more than a limit (current limit of 2018-19 is 2,50,000 per year) has to pay some part of their earning as tax to the Income-tax Department.

How to calculate income tax?

Calculating income tax is a little detailed, but simple procedure and it depends on 2 basic factors.

  1. Taxable income
  2. Age Slab

Let’s see the first factor i.e. taxable income.

What is taxable income?

Tax is paid on “Taxable Income” and not your full income. There is something called “Exemptions” and “Deductions” which are reduced from your income to arrive at “Taxable Income”. Formula to calculate taxable income is given below:

#1: What is Gross income?

Gross income is your total earning. It is the entire amount of your income without any deduction or exemptions. Gross income is not only your salaried income. It is the income you earn from all your earning sources.

For example: In one month, If you earn Rs.50,000 as salary, Rs 25,000 from your house rent and Rs.20,000 from your other business.

Then your gross monthly income will be : 50,000 + 25,000 + 20,000 = Rs. 95,000

There are various sources of income which are classified into 5 categories. The categories are called 5 heads of income.

5 heads of Income:

Each and every source of earning from where you are getting money is considered as your income. There are 5 main sources which are also called as 5 heads of income which are considered as the main income sources. These 5 heads are as bellow:

 

Let me tell about these sources in detail.

1. Income from salary

The first head is “Income from Salary”, so if you are a salaried employee, then your whole year salary has to be added, less exempt HRA and other perquisites (covered below in this article) which are allowed to be tax-exempt. So, this amount is to be shown under the head of the salary. It does not matter if you are a govt employee or work in the private sector.

2. Income from house property:

If you have a property and you have given it on rent, then all the rent earned in a year will be considered as your “Income from House Property”.

3. Income from profit or gains from business:

If you have your own business, then all the profits you generate from that business will be considered under this head. For example, if you have a shop, and your revenue is 5 lacs a year, but your expenses in shop is 3 lacs, then your profit is Rs 2 lacs. This 2 lacs will be considered as your income under this head.

4. Income from Capital Gains:

Capital assets can be simply defined as the property you own, which includes Stocks, mutual funds, real estate, gold, etc.  So the profit you earn through the sale of these assets is considered as a capital gain and it will be taxable depending upon the class of asset from which capital gain occurred. For example gain on capital assets like equity stocks or equity mutual funds is taxable at 10% above Rs 1 lacs profits in a financial year.

5. Income from other sources:

The sources of income other than the above-mentioned classes are considered under 5th head of income. For example –  the money you receive from any relative or friend as a gift above Rs 50,000 or any award prize or lottery you won, etc will come under this head.

Most of the people who are salaried will not have to deal with the other 4 heads of income for many years.

#2: What are deductions and exemptions?

Now let’s understand the very important concept of “deductions” and “exemptions”. These two things can be reduced from your gross income and your taxable income can come down, which will result in lower taxes

In this article, we have covered exemption available to salaried employees on receipt of allowances and perquisites from employer. Let’s see the examples of Tax Exemptions and deduction:

Tax Exemptions

“Exemptions” are some of the defined benefits or heads which can be deducted from income. A person spends on some of the necessities in life like paying rent, spending money on children’s fees, and basic living expenses. So some of the exemptions allowed are

  • HRA (house rent allowance)
  • Standard Deduction of Rs 50,000 per year
  • Children Education Allowance + Hostel Allowance
  • LTA (Leave travel allowance)

Let’s understand these 3 things.

Exemption #1 – House Rent Allowance (HRA)

If you are receiving HRA as part of your salary and also pay rent for residential accommodation then you can claim the HRA paid to you as exempt from tax subject to certain limits and restrictions. These are as follows:

Minimum of the following HRA is exempt from tax –

(i) Actual HRA received

(ii) 50% of annual salary* if living in metro cities or else 40%

(iii) Actual Rent paid less 10% of Basic + DA

Exemption #2 –  Standard Deduction of Rs 50,000

Once can directly deduct a standard deduction of Rs 50,000 and bring down their income by that margin. Before Financial Year 2018-19, there was a deduction available for Travel Allowance (Rs 19,200) and Medical expenses (Rs 15,000) when you produced the bills, but now there is no requirement of producing any proof of expenses. One can directly take the benefit of Rs 50,000 standard deduction (for FY 2018-19, this was Rs 40,000, but later it was increased to Rs 50,000)

Exemption #3 – Children Education Allowance + Hostel Allowance

If you are receiving children education allowance or hostel allowance from your employer then you are eligible to claim a tax exemption under the Income Tax Act. However, here are the limits for these two exemptions

  • Children’s Education Allowance: INR 100 per month per child up to a maximum of 2 children.
  • Hostel Expenditure Allowance: INR 300 per month per child up to a maximum of 2 children.

Exemption #4 – LTA (Leave Travel Allowance)

A lot of employers give an allowance to employees for traveling on leave dates. An employee may travel for his holidays or vacations (alone or family) and will incur some expenses related to that. So this allowance is given for that on producing the bills and on doing the actual travel by taking leaves.

The actual rules for LTA are quite detailed, hence we are not covering it here in this article. Right now you just need to know that the employer can define the LTA allowance limit like Rs 50,000 (for example), so that employee can do travel expenses upto that limit twice in a block of 4 yrs and claim this exemption.

Tax Deductions

There are various deductions that are available under different sections of the income tax act. This deduction is against amounts that you have invested in some specific products like Insurance, ELSS, or ULIP and it also considers specific types of expenses that you incurred during a financial year like Principal repayment of loan, donations or health insurance premiums, etc.

 

Here is the table given below in which you can see various sections covered under section 80 (from 80C, 80D up to 80U), their meaning, maximum limit of deductions and who can avail the benefit of these deductions.

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