Have you just started your first job or are you planning to file your first income tax return this year but have no clue about it? Let me tell you that you’re not alone! Every April marks the beginning of a new fiscal year, and with it comes the possibilities of better tax planning and making the right financial moves.
The clamour that I see among some of my friends each year to find avenues to save tax is something that can easily be done away with.
In the next 5 minutes, I’ll attempt to help you understand the basic concepts of Income Tax, and by the end of it, you should probably have a better idea of planning out your taxes. Come, walk with me then.
Income tax is basically a tax on the money you make. It's like the government's way of dipping their hands in your pocket and taking a slice of the pie. The more money you earn, the more tax you have to pay. It's used to fund public services like schools and hospitals, so basically, you're paying for your own education and healthcare, whether you like it or not! The rules and rates can vary depending on where you live, so it's always a good idea to check with your local tax authority.
Income tax slabs refer to the different tax rates that apply to different levels of income. These rates are set by the government and vary from country to country. In general, the higher your income, the higher your tax rate will be.
Income tax exemptions and deductions are ways in which taxpayers can reduce their taxable income and therefore lower the amount of tax they have to pay. These can include things like:
This is a fixed deduction available to salaried individuals on their gross salary. It is currently ₹50,000 per year in India.
This includes investments in things like Public Provident Fund (PPF), Equity-Linked Savings Scheme (ELSS), National Pension System (NPS), and life insurance policies, up to a maximum of ₹1.5 lakh per year.
This includes deductions for health insurance premiums paid for self, spouse, children, and parents.
Interest paid on home loans is deductible up to ₹2 lakh per year in India.
This includes deductions for tuition fees paid for children's education.
It is important for taxpayers to be aware of these exemptions and deductions in order to maximise their tax savings and reduce their tax liability.
The year 2020 brought a new regime with the option for taxpayers to choose which one to use. However, before deciding on the regime to file your returns, it’s imperative to understand the difference between the two.
The new tax regime has more slabs with lower tax rates and almost all the usual income tax exemptions present in the existing regime (ironically, now referred to as the old regime) are not applicable here. With the flexibility to choose, the regime cannot be changed for the existing financial year once you make a choice. So it’s always advisable to compare the two regimes using online calculators before finalising.
The right choice depends entirely on your gross annual income and the tax-saving tools you have been using. When I had to make this choice two years ago, I took the first step to calculating my net taxable income. I did this by taking my gross income and subtracting the standard deduction of ₹50K, other exemptions like HRA, LTA etc., the voluntary investments to avail Sec 80C deductions (LIC, PF, ELSS, NPS etc.) and the Section 80D deductions (Medical Insurance, Critical Health Insurance etc.).
Having done this, I did another round of calculations using the new tax regime slabs with no deductions permissible. If manual calculations are not your cup of tea, you can use a host of free online calculators to arrive at your decision. The bottom line is that you should have clarity on the tax liability in both scenarios. Here is a table for easy reference while making your calculations.
In my case, specifically, I maximise my Sec 80C deductions (limit ₹1.5 Lakh). Moreover, I also claim deductions for HRA as per the permissible limit. Choosing the new tax regime will make me miss out on these, increasing my taxable income and net tax amount. So, naturally, I have stuck around with the old tax regime.
Okay, so if you have other sources of income apart from your regular salary, and your tax liability for the financial year is more than ₹10,000, you’ll have to pay something known as advance tax. Examples include rent from property, interest earned on fixed deposits or savings accounts, capital gains from selling shares of mutual funds, etc.
The calculation is fairly simple since no external factors are involved here. All you have to do is
1. Estimate your earnings for the year from non-salary sources, as mentioned above.
2. Then the combined income needs to be added to your gross salary for the year.
3. Now, use the income tax slabs for the old or new regime (as opted for) and calculate the tax applicable.
4. From this amount, you should subtract the already deducted TDS and the other income tax deductions for salaried employees (in the old regime).
If the delta amount exceeds ₹10K, then you are required to pay advance tax. Typically, the 15th of March of each year is the deadline for 100% payment of the advance tax. If not, there is a penalty of 1% per month till the due amount is paid.
Fortunately, the process for payment of advance is rather simple. It can be done conveniently online on the Income Tax website and help you save on avoidable late fees and penalties.
As I previously mentioned, the new tax regime doesn’t offer many deductions, and if I’m going to save on tax, then deductions are something I’ll need to maximise. So, in all fairness, it makes more sense for me to stick to the old regime. Under this, I can maximise the following deductions:
So, you see, tax planning is no rocket science. All it takes is careful consideration of your annual earnings and proper research into the various tax-saving tools available for you to invest. Pay special attention to your preferred investment horizon, and risk appetite. Don’t let tax-saving concerns carry you away and drive you into locking a chunk of your money for long periods, rendering you unable to fulfil your short or mid-term goals.
It's crucial to grasp income tax fundamentals to handle your finances and adhere to tax regulations. Familiarising yourself with income types, tax brackets, deductions, credits, and the tax return process empowers you to navigate taxation with confidence. Don't forget to proactively plan your taxes and consult experts to optimise savings and prevent IRS complications.
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The basic concept of income refers to the money or earnings that an individual or entity receives from various sources such as employment, investments, or business operations. It is the amount of money that an individual or entity earns during a specific period, such as a year or a month.
The four basic income tax steps are:
1. Calculate taxable income by accounting for deductions and exemptions.
2. Determine the tax rate and calculate the owed amount.
3. Pay the owed tax to the government.
4. File tax returns, reporting income and deductions to tax authorities.
