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Tax Planning

How is taxable income calculated?

12 May 2017
Here's why that amount gets deducted from your salary before it hits your bank account!
 

One of the most common questions that pops up during the tax filing season is ’What is my taxable income? ’The best answer for this could be a counter-question: ’What is not taxable?’

Why is this the best reply? This is because in India, all income is taxable, unless it is specifically excluded.

Related: Components of your salary and their tax benefits

Most income is taxable, and must be reported in your tax returns. But it is important to note that some income is only taxable in part. In certain cases, income is not taxable at all. This article will help you determine your taxable income, and will explain the different tax slabs that apply to taxpayers.

Before finding your taxable income, however, you need to first calculate your total income.

First, tally your income from various sources.

For example, let’s say you are a bank employee in Bangalore, earning a monthly salary. You own a residential property, from which you earn rent. You also earn from the sale of assets, equities. This comes under income from capital gains. So, your total income is the sum of your salary, rental income, and capital gains.

Next, subtract the tax-free earnings from the total income. These would be, for example, gains from equity shares if held for more than a year.

You should also check your salary for taxable and non-taxable components.

The following components are included in your salary:

1)    Basic Salary

2)    Bonuses and commissions

3)    Allowances (these can be taxed fully, partially or totally exempt from tax)

Fully taxable allowances include Dearness Allowance (DA), Overtime Allowance (OA) and city compensatory allowance (for those who move to metros like Mumbai, Delhi, Kolkata, and Chennai).

Partly taxable allowances include House Rent Allowance (HRA), entertainment allowance, and other special allowances.

Fully exempt allowances include foreign allowance (for employees who are posted in other countries), allowance of high court and supreme court judges, etc.

Here’s an example of a salary structure:

Taxable annual salary

Salary Income

Tax exemption

Taxable income

Basic pay

8,00,000

-

8,00,000

HRA

3,00,000

1,72,000*

1,28,000

Transport Allowance

96,000

19,200 (1,600 per month)

76,800

Special Allowances

60,000

-

60,000

Leave Travel Allowance

20,000

12,000

8,000

Medical Bills

15,000

15,000

-

Gross Total

12,91,000

2,18,200

10,72,800

*HRA is calculated as the lower of the following three:

- Actual HRA

- 40% of the Basic pay

- Actual rent paid minus 10% of basic pay

In this case:

- Actual HRA is Rs 3 lakhs

- 40% of basic pay is Rs 3.2 lakhs

- The actual rent paid is Rs 21,000 per month. This amounts to a yearly rent of Rs 2.52 lakhs. So, Rs 2.52 lakh minus 10% of basic pay comes to Rs 1.72 lakh. This is the lowest amount, and hence is used for tax exemption.

Finally, deduct the money you invest in various tax-saving options under various sections of the Income Tax Act like 80C, 80D, 80TTA, 80CCC, etc. Under these tax-saving rules, you can invest up to Rs 1.5 lakhs in investments such as life insurance plans, Public Provident Funds (PPF), National Pension System (NPS), Retirement mutual funds, equities, ULIPs and so on.

Section 80D allows you to claim a deduction of up to Rs 25,000 on medical insurance premium you have paid during the year for self, spouse & children. This includes a tax exemption of Rs 5,000 that you can avail on preventive health check-up.

Under section 80TTA, you can claim an exemption of Rs 10,000 on interest received from saving account deposits. This is applicable only to individual taxpayers and Hindu Undivided Family (HUFs).

Related: How women can save tax in India

A simple formula gives you the final result:

Taxable income = Gross income – (deductions + exemptions)

Now, you can calculate the taxable income under Indian IT laws using the current, applicable tax rates.

Let us see how to calculate tax using an example.

Manish is a software employee. He earns Rs 9.5 lakhs per year.

During the year, his income from a savings account is Rs 10,000. He has a fixed deposit (FD) that gives him an annual interest income of Rs 12,000. He also invested Rs 50,000 in Public Provident Fund (PPF) and Rs 20,000 in tax-saving mutual funds.

Over the last year, he paid a premium of Rs 80,000 for a life insurance policy, and paid Rs 10,000 for medical insurance.

From the above data, Manish’s gross total income calculations (in Rs) are:

Nature of income

Amount

Salary

9,50,000

Other sources

22,000 (Savings Account + FD)

Gross total income

9,72,000

His deductions (in Rs) are:

Deductions

Amount

80C

1,50,000 (PPF+ELSS funds+ LIC policy)

80D

10,000 (medical insurance)

80TTA

10,000 (savings account)

Total

170,000

Gross Taxable Income = Gross Total Income – Deductions

So, Manish’s Gross Taxable Income = Rs 9,72,000–1,70,000 = Rs 8,02,000.

Related: Non-80C items that help you save tax

Finally, Manish’s income tax calculations are:

Up to Rs 250,000       

 

Exempt from tax        

0

Rs 2,50,000 to Rs 5,00,000

5% (5% of Rs 2.5 lakh)

12,500

Rs 5,00,000 to Rs 10,00,000

20% (20% of Rs 8.02 lakhs minus Rs 5 lakh)

60,400

More than Rs 10,00,000

30%

0

Cess

3% of Total Tax

2,187

Total income tax

12,500+60,400+2,187

75,087

So, Manish pays an income tax of Rs 75,087.

Related: Most important income tax changes from 1st April 2017

Important point to remember:

Manish is a salaried individual. Had he been a professional or business owner, he would have to file his income taxes in a different way. For example, professionals can deduct expenses directed towards their work, like car expenses. This can be deducted from the taxable income. Business-owners, meanwhile, should conduct a tax audit first by a qualified chartered accountant. Only then should they file their income tax returns.

Knowing all this will help you understand exactly how your income is taxed, and with careful planning, you can even help you save on your taxable income.

Related: Gifts and Taxes: how much does it cost to make someone happy?

 
 
 

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